To the annoyance of some shareholders, Interface (NASDAQ:TILE) shares are down a considerable 30% in the last month. Indeed the recent decline has arguably caused some bitterness for shareholders who have held through the 53% drop over twelve months.
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. 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 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 Interface Have A Relatively High Or Low P/E For Its Industry?
Interface’s P/E of 12.68 indicates relatively low sentiment towards the stock. We can see in the image below that the average P/E (23.4) for companies in the commercial services industry is higher than Interface’s P/E.
This suggests that market participants think Interface will underperform other companies in its industry.
How Growth Rates Impact P/E Ratios
If earnings fall then in the future the ‘E’ will be lower. That means unless the share price falls, the P/E will increase in a few years. So while a stock may look cheap based on past earnings, it could be expensive based on future earnings.
Interface saw earnings per share decrease by 13% last year. But over the longer term (5 years) earnings per share have increased by 3.8%. And over the longer term (3 years) earnings per share have decreased 7.8% annually. This growth rate might warrant a low P/E ratio.
Remember: P/E Ratios Don’t Consider The Balance Sheet
It’s important to note that the P/E ratio considers the market capitalization, not the enterprise value. 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 Interface’s P/E?
Net debt totals 93% of Interface’s market cap. If you want to compare its P/E ratio to other companies, you should absolutely keep in mind it has significant borrowings.
The Bottom Line On Interface’s P/E Ratio
Interface’s P/E is 12.7 which is below average (17) in the US market. When you consider that the company has significant debt, and didn’t grow EPS last year, it isn’t surprising that the market has muted expectations. Given Interface’s P/E ratio has declined from 18.1 to 12.7 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.
Investors have an opportunity when market expectations about a stock are wrong. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. 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 Interface. 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).
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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.