To the annoyance of some shareholders, Ollie’s Bargain Outlet Holdings (NASDAQ:OLLI) shares are down a considerable 33% in the last month. Indeed the recent decline has arguably caused some bitterness for shareholders who have held through the 36% drop over twelve months.
All else being equal, a share price drop should make a stock more attractive to potential investors. 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 Ollie’s Bargain Outlet Holdings’s P/E Ratio Compare To Its Peers?
We can tell from its P/E ratio of 25.24 that there is some investor optimism about Ollie’s Bargain Outlet Holdings. As you can see below, Ollie’s Bargain Outlet Holdings has a higher P/E than the average company (11.1) in the multiline retail industry.
Ollie’s Bargain Outlet Holdings’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
P/E ratios primarily reflect market expectations around earnings growth rates. Earnings growth means that in the future the ‘E’ will be higher. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
Ollie’s Bargain Outlet Holdings saw earnings per share decrease by 8.7% last year. But EPS is up 32% over the last 5 years.
Remember: P/E Ratios Don’t Consider The Balance Sheet
The ‘Price’ in P/E reflects the market capitalization of the company. That means it doesn’t take debt or cash into account. The exact same company would hypothetically deserve a higher P/E ratio if it had a strong balance sheet, than if it had a weak one with lots of debt, because a cashed up company can spend on growth.
Such spending might be good or bad, overall, but the key point here is that you need to look at debt to understand the P/E ratio in context.
So What Does Ollie’s Bargain Outlet Holdings’s Balance Sheet Tell Us?
Since Ollie’s Bargain Outlet Holdings holds net cash of US$78m, it can spend on growth, justifying a higher P/E ratio than otherwise.
The Verdict On Ollie’s Bargain Outlet Holdings’s P/E Ratio
Ollie’s Bargain Outlet Holdings’s P/E is 25.2 which is above average (17.3) in its market. Falling earnings per share is probably keeping traditional value investors away, but the net cash position means the company has time to improve: and the high P/E suggests the market thinks it will. Given Ollie’s Bargain Outlet Holdings’s P/E ratio has declined from 37.5 to 25.2 in the last month, we know for sure that the market is significantly less confident about the business today, than it was back then. For those who don’t like to trade against momentum, that could be a warning sign, but a contrarian investor might want to take a closer look.
When the market is wrong about a stock, it gives savvy investors an opportunity. As value investor Benjamin Graham famously said, ‘In the short run, the market is a voting machine but in the long run, it is a weighing machine.’ So this free visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.
Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.
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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.