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A Rising Share Price Has Us Looking Closely At Pets at Home Group Plc's (LON:PETS) P/E Ratio

Simply Wall St

at Home Group (LON:PETS) shares have had a really impressive month, gaining 31%, after some slippage. That's tops off a massive gain of 117% 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. 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). Investors have optimistic expectations of companies with higher P/E ratios, compared to companies with lower P/E ratios.

See our latest analysis for at Home Group

How Does at Home Group's P/E Ratio Compare To Its Peers?

at Home Group's P/E of 26.86 indicates some degree of optimism towards the stock. The image below shows that at Home Group has a higher P/E than the average (16.1) P/E for companies in the specialty retail industry.

LSE:PETS Price Estimation Relative to Market, December 11th 2019
LSE:PETS Price Estimation Relative to Market, December 11th 2019

at Home Group's P/E tells us that market participants think the company will perform better than its industry peers, going forward. 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

When earnings fall, the 'E' decreases, over time. That means even if the current P/E is low, it will increase over time if the share price stays flat. Then, a higher P/E might scare off shareholders, pushing the share price down.

Notably, at Home Group grew EPS by a whopping 36% in the last year. And its annual EPS growth rate over 5 years is 14%. With that performance, I would expect it to have an above average P/E ratio. Unfortunately, earnings per share are down 13% a year, over 3 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.

Spending on growth might be good or bad a few years later, but the point is that the P/E ratio does not account for the option (or lack thereof).

at Home Group's Balance Sheet

at Home Group has net debt worth 10% of its market capitalization. That's enough debt to impact the P/E ratio a little; so keep it in mind if you're comparing it to companies without debt.

The Bottom Line On at Home Group's P/E Ratio

at Home Group trades on a P/E ratio of 26.9, which is above its market average of 17.2. Its debt levels do not imperil its balance sheet and its EPS growth is very healthy indeed. So to be frank we are not surprised it has a high P/E ratio. What we know for sure is that investors have become much more excited about at Home Group recently, since they have pushed its P/E ratio from 20.5 to 26.9 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. As value investor Benjamin Graham famously said, 'In the short run, the market is a voting machine but in the long run, it is a weighing machine. So this free report on the analyst consensus forecasts could help you make a master move on this stock.

You might be able to find a better buy than at Home Group. 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 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.

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