To the annoyance of some shareholders, Stitch Fix (NASDAQ:SFIX) shares are down a considerable 31% in the last month. That drop has capped off a tough year for shareholders, with the share price down 50% in that time.
Assuming nothing else has changed, a lower share price makes a stock more attractive to potential buyers. In the long term, share prices tend to follow earnings per share, but in the short term prices bounce around in response to short term factors (which are not always obvious). The implication here is that long term investors have an opportunity when expectations of a company are too low. One way to gauge market expectations of a stock is to look at its Price to Earnings Ratio (PE Ratio). Investors have optimistic expectations of companies with higher P/E ratios, compared to companies with lower P/E ratios.
How Does Stitch Fix’s P/E Ratio Compare To Its Peers?
Stitch Fix’s P/E of 40.78 indicates some degree of optimism towards the stock. You can see in the image below that the average P/E (30.1) for companies in the online retail industry is lower than Stitch Fix’s P/E.
Stitch Fix’s P/E tells us that market participants think the company will perform better than its industry peers, going forward.
How Growth Rates Impact P/E Ratios
Earnings growth rates have a big influence on P/E ratios. If earnings are growing quickly, then the ‘E’ in the equation will increase faster than it would otherwise. That means unless the share price increases, the P/E will reduce in a few years. And as that P/E ratio drops, the company will look cheap, unless its share price increases.
Stitch Fix’s 52% EPS improvement over the last year was like bamboo growth after rain; rapid and impressive. Having said that, the average EPS growth over the last three years wasn’t so good, coming in at 8.8%.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
Don’t forget that the P/E ratio considers market capitalization. Thus, the metric does not reflect cash or debt held by the company. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
While growth expenditure doesn’t always pay off, the point is that it is a good option to have; but one that the P/E ratio ignores.
Is Debt Impacting Stitch Fix’s P/E?
With net cash of US$292m, Stitch Fix has a very strong balance sheet, which may be important for its business. Having said that, at 15% of its market capitalization the cash hoard would contribute towards a higher P/E ratio.
The Bottom Line On Stitch Fix’s P/E Ratio
Stitch Fix has a P/E of 40.8. That’s higher than the average in its market, which is 17. The excess cash it carries is the gravy on top its fast EPS growth. So based on this analysis we’d expect Stitch Fix to have a high P/E ratio. What can be absolutely certain is that the market has become significantly less optimistic about Stitch Fix over the last month, with the P/E ratio falling from 59.2 back then to 40.8 today. For those who prefer to invest with the flow of momentum, that might be a bad sign, but for a contrarian, it may signal opportunity.
Investors have an opportunity when market expectations about a stock are wrong. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.
Of course you might be able to find a better stock than Stitch Fix. So you may wish to see this free collection of other companies that have grown earnings strongly.
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If you spot an error that warrants correction, please contact the editor at email@example.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.