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Unfortunately for some shareholders, the Nick Scali (ASX:NCK) share price has dived 57% in the last thirty days. Indeed the recent decline has arguably caused some bitterness for shareholders who have held through the 44% 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. Perhaps the simplest way to get a read on investors' expectations of a business 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.
Check out our latest analysis for Nick Scali
How Does Nick Scali's P/E Ratio Compare To Its Peers?
We can tell from its P/E ratio of 6.90 that there is some investor optimism about Nick Scali. You can see in the image below that the average P/E (5.9) for companies in the specialty retail industry is lower than Nick Scali's P/E.
Its relatively high P/E ratio indicates that Nick Scali 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 delve deeper. I like to check if company insiders have been buying or selling.
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. And in that case, the P/E ratio itself will drop rather quickly. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
Nick Scali saw earnings per share decrease by 11% last year. But over the longer term (5 years) earnings per share have increased by 18%.
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. Theoretically, a business can improve its earnings (and produce a lower P/E in the future) by investing in growth. That means taking on debt (or spending its cash).
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.