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Liberty Shoes (NSE:LIBERTSHOE) shares have had a really impressive month, gaining 38%, after some slippage. But shareholders may not all be feeling jubilant, since the share price is still down 38% in the last year.
Assuming no other changes, a sharply higher share price makes a stock less attractive to potential buyers. 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). So some would prefer to hold off buying when there is a lot of optimism towards a stock. 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.
View our latest analysis for Liberty Shoes
Does Liberty Shoes Have A Relatively High Or Low P/E For Its Industry?
We can tell from its P/E ratio of 27.45 that there is some investor optimism about Liberty Shoes. The image below shows that Liberty Shoes has a higher P/E than the average (10.8) P/E for companies in the luxury industry.
Liberty Shoes's P/E tells us that market participants think the company will perform better than its industry peers, going forward. Clearly the market expects growth, but it isn't guaranteed. 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
When earnings fall, the 'E' decreases, over time. That means unless the share price falls, the P/E will increase in a few years. A higher P/E should indicate the stock is expensive relative to others -- and that may encourage shareholders to sell.
Liberty Shoes shrunk earnings per share by 11% over the last year. And over the longer term (5 years) earnings per share have decreased 12% annually. This could justify a pessimistic P/E.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. Thus, the metric does not reflect cash or debt held by the company. 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.
How Does Liberty Shoes's Debt Impact Its P/E Ratio?
Liberty Shoes's net debt is 52% of its market cap. If you want to compare its P/E ratio to other companies, you should absolutely keep in mind it has significant borrowings.