Unfortunately for some shareholders, the Industria de Diseño Textil (BME:ITX) share price has dived 34% in the last thirty days. The recent drop has obliterated the annual return, with the share price now down 16% over that longer period.
Assuming nothing else has changed, a lower share price makes a stock more attractive to potential buyers. While the market sentiment towards a stock is very changeable, in the long run, the share price will tend to move in the same direction as earnings per share. So, on certain occasions, long term focussed investors try to take advantage of pessimistic expectations to buy shares at a better price. 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.
Does Industria de Diseño Textil Have A Relatively High Or Low P/E For Its Industry?
We can tell from its P/E ratio of 17.61 that there is some investor optimism about Industria de Diseño Textil. You can see in the image below that the average P/E (10.5) for companies in the specialty retail industry is lower than Industria de Diseño Textil’s P/E.
That means that the market expects Industria de Diseño Textil will outperform other companies in its industry. Shareholders are clearly optimistic, but the future is always uncertain. So investors should delve deeper. I like to check if company insiders have been buying or selling.
How Growth Rates Impact P/E Ratios
P/E ratios primarily reflect market expectations around earnings growth rates. When earnings grow, the ‘E’ increases, over time. That means even if the current P/E is high, it will reduce over time if the share price stays flat. Then, a lower P/E should attract more buyers, pushing the share price up.
Industria de Diseño Textil increased earnings per share by 7.5% last year. And its annual EPS growth rate over 5 years is 9.3%.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
The ‘Price’ in P/E reflects the market capitalization of the company. In other words, it does not consider any debt or cash that the company may have on the balance sheet. 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.
Industria de Diseño Textil’s Balance Sheet
With net cash of €7.7b, Industria de Diseño Textil has a very strong balance sheet, which may be important for its business. Having said that, at 12% of its market capitalization the cash hoard would contribute towards a higher P/E ratio.
The Verdict On Industria de Diseño Textil’s P/E Ratio
Industria de Diseño Textil has a P/E of 17.6. That’s higher than the average in its market, which is 14.4. EPS was up modestly better over the last twelve months. Also positive, the relatively strong balance sheet will allow for investment in growth — and the P/E indicates shareholders that will happen! What can be absolutely certain is that the market has become significantly less optimistic about Industria de Diseño Textil over the last month, with the P/E ratio falling from 26.7 back then to 17.6 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.
You might be able to find a better buy than Industria de Diseño Textil. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
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.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.