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Herbalife Nutrition (NYSE:HLF) shares have had a really impressive month, gaining 31%, after some slippage. But shareholders may not all be feeling jubilant, since the share price is still down 28% in the last year.
All else being equal, a sharp share price increase should make a stock less attractive to potential investors. 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). The implication here is that deep value investors might steer clear when expectations of a company are too high. 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.
Does Herbalife Nutrition Have A Relatively High Or Low P/E For Its Industry?
Herbalife Nutrition's P/E of 16.87 indicates some degree of optimism towards the stock. You can see in the image below that the average P/E (13.3) for companies in the personal products industry is lower than Herbalife Nutrition's P/E.
Its relatively high P/E ratio indicates that Herbalife Nutrition shareholders think it will perform better than other companies in its industry classification. Clearly the market expects growth, but it isn't guaranteed. So further research is always essential. I often monitor director buying and selling.
How Growth Rates Impact P/E Ratios
Probably the most important factor in determining what P/E a company trades on is the earnings growth. Earnings growth means that in the future the 'E' will be higher. That means even if the current P/E is high, it will reduce over time if the share price stays flat. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.
Herbalife Nutrition's earnings per share grew by 7.0% in the last twelve months. And earnings per share have improved by 4.8% annually, over the last five years.
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. 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 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 Herbalife Nutrition's P/E?
Herbalife Nutrition's net debt is 18% of its market cap. It would probably deserve a higher P/E ratio if it was net cash, since it would have more options for growth.
The Verdict On Herbalife Nutrition's P/E Ratio
Herbalife Nutrition has a P/E of 16.9. That's higher than the average in its market, which is 14.9. 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. What we know for sure is that investors have become more excited about Herbalife Nutrition recently, since they have pushed its P/E ratio from 12.9 to 16.9 over the last month. For those who prefer to invest with the flow of momentum, that might mean it's time to put the stock on a watchlist, or research it. But the contrarian may see it as a missed opportunity.
Investors have an opportunity when market expectations about a stock are wrong. 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 visual report on analyst forecasts could hold the key to an excellent investment decision.
You might be able to find a better buy than Herbalife Nutrition. 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).
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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