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What Is Baby Bunting Group's (ASX:BBN) P/E Ratio After Its Share Price Tanked?

To the annoyance of some shareholders, Baby Bunting Group (ASX:BBN) shares are down a considerable 30% in the last month. Indeed, the recent drop has reduced the annual gain to a relatively sedate 5.1% over the last twelve months.

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.

View our latest analysis for Baby Bunting Group

Does Baby Bunting Group Have A Relatively High Or Low P/E For Its Industry?

Baby Bunting Group's P/E of 25.13 indicates some degree of optimism towards the stock. The image below shows that Baby Bunting Group has a higher P/E than the average (11.2) P/E for companies in the specialty retail industry.

ASX:BBN Price Estimation Relative to Market, March 12th 2020
ASX:BBN Price Estimation Relative to Market, March 12th 2020

That means that the market expects Baby Bunting Group will outperform other companies in its industry. The market is optimistic about the future, but that doesn't guarantee future growth. 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

Earnings growth rates have a big influence on P/E ratios. When earnings grow, the 'E' increases, over time. That means unless the share price increases, the P/E will reduce in a few years. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.

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Notably, Baby Bunting Group grew EPS by a whopping 31% in the last year. And earnings per share have improved by 9.5% annually, over the last five years. I'd therefore be a little surprised if its P/E ratio was not relatively high.

Don't Forget: The P/E Does Not Account For Debt or Bank Deposits

It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. So it won't reflect the advantage of cash, or disadvantage of debt. In theory, a company can lower its future P/E ratio by using cash or debt to invest in 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.

How Does Baby Bunting Group's Debt Impact Its P/E Ratio?

Baby Bunting Group has net debt worth just 3.1% of its market capitalization. It would probably trade on a higher P/E ratio if it had a lot of cash, but I doubt it is having a big impact.

The Verdict On Baby Bunting Group's P/E Ratio

Baby Bunting Group trades on a P/E ratio of 25.1, which is above its market average of 15.9. While the company does use modest debt, its recent earnings growth is superb. So to be frank we are not surprised it has a high P/E ratio. Given Baby Bunting Group's P/E ratio has declined from 35.9 to 25.1 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. People often underestimate remarkable growth -- so investors can make money when fast growth is not fully appreciated. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.

Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.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.