To the annoyance of some shareholders, Scholastic (NASDAQ:SCHL) shares are down a considerable 37% in the last month. That drop has capped off a tough year for shareholders, with the share price down 46% in that time.
All else being equal, a share price drop should make a stock more attractive to potential investors. 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). A high P/E ratio means that investors have a high expectation about future growth, while a low P/E ratio means they have low expectations about future growth.
Does Scholastic Have A Relatively High Or Low P/E For Its Industry?
Scholastic’s P/E of 42.79 indicates some degree of optimism towards the stock. You can see in the image below that the average P/E (9.1) for companies in the media industry is a lot lower than Scholastic’s P/E.
Its relatively high P/E ratio indicates that Scholastic shareholders think it will perform better than other companies in its industry classification. Shareholders are clearly optimistic, but the future is always uncertain. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.
How Growth Rates Impact P/E Ratios
If earnings fall then in the future the ‘E’ will be lower. Therefore, even if you pay a low multiple of earnings now, that multiple will become higher in the future. Then, a higher P/E might scare off shareholders, pushing the share price down.
Scholastic increased earnings per share by a whopping 49% last year. Unfortunately, earnings per share are down 32% a year, over 3 years.
Remember: P/E Ratios Don’t Consider The Balance Sheet
Don’t forget that the P/E ratio considers market capitalization. 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.
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.
Is Debt Impacting Scholastic’s P/E?
With net cash of US$262m, Scholastic has a very strong balance sheet, which may be important for its business. Having said that, at 35% of its market capitalization the cash hoard would contribute towards a higher P/E ratio.
The Bottom Line On Scholastic’s P/E Ratio
Scholastic has a P/E of 42.8. That’s significantly higher than the average in its market, which is 11.8. Its net cash position is the cherry on top of its superb EPS growth. So based on this analysis we’d expect Scholastic to have a high P/E ratio. Given Scholastic’s P/E ratio has declined from 68.3 to 42.8 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 prefer to invest with the flow of momentum, that might be a bad sign, but for a contrarian, it may signal opportunity.
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.
But note: Scholastic may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
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.