To the annoyance of some shareholders, H & M Hennes & Mauritz (STO:HM B) shares are down a considerable 35% in the last month. The recent drop has obliterated the annual return, with the share price now down 7.8% over that longer period.
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. 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). A high P/E implies that investors have high expectations of what a company can achieve compared to a company with a low P/E ratio.
How Does H & M Hennes & Mauritz's P/E Ratio Compare To Its Peers?
H & M Hennes & Mauritz's P/E of 16.24 indicates some degree of optimism towards the stock. The image below shows that H & M Hennes & Mauritz has a higher P/E than the average (14.5) P/E for companies in the specialty retail industry.
Its relatively high P/E ratio indicates that H & M Hennes & Mauritz shareholders think it will perform better than other companies in its industry classification. Clearly the market expects growth, but it isn't guaranteed. So investors should delve deeper. I like to check if company insiders have been buying or selling.
How Growth Rates Impact P/E Ratios
When earnings fall, the 'E' decreases, over time. 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.
H & M Hennes & Mauritz increased earnings per share by 6.3% last year. Unfortunately, earnings per share are down 7.6% a year, over 5 years.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
Don't forget that the P/E ratio considers market capitalization. So it won't reflect the advantage of cash, or disadvantage of debt. 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 expenditure might be good or bad, in the long term, but the point here is that the balance sheet is not reflected by this ratio.
H & M Hennes & Mauritz's Balance Sheet
Net debt totals just 2.0% of H & M Hennes & Mauritz's market cap. The market might award it a higher P/E ratio if it had net cash, but its unlikely this low level of net borrowing is having a big impact on the P/E multiple.
The Bottom Line On H & M Hennes & Mauritz's P/E Ratio
H & M Hennes & Mauritz's P/E is 16.2 which is above average (14.5) in its market. Given the debt is only modest, and earnings are already moving in the right direction, it's not surprising that the market expects continued improvement. Given H & M Hennes & Mauritz's P/E ratio has declined from 25.1 to 16.2 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 prefer to invest with the flow of momentum, that might be a bad sign, but for a contrarian, it may signal opportunity.
Investors should be looking to buy stocks that the market is wrong about. 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 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 be able to find a better stock than H & M Hennes & Mauritz. So you may wish to see this free collection of other companies that have grown earnings strongly.
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.
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