High PE Ratios: Always a Precursor to High Growth Expectations?
Lessons from the Footwear Sector
In the world of investing, the Price-to-Earnings (PE) ratio is often hailed as a key indicator of market expectations. A high PE multiple typically suggests that investors are betting on robust future growth, willing to pay a premium for earnings that are expected to skyrocket.
But is this always the case? Or could it sometimes reflect overhyped optimism detached from reality?
Recently, while screening stocks in the consumption space, I delved into over 13 sub-sectors: including liquor, hospitality, shopping centres, and fashion brands.
Most areas showed varying degrees of promise, but one sector stood out for all the wrong reasons: footwear.
The growth numbers here were downright discouraging, prompting me to question what the market is truly pricing in with these lofty valuations.
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The Footwear Sector: A Snapshot of Stagnation
There are about eight listed players in the Indian footwear market, with three of them sporting market caps below 500 crore rupees.
When I looked at their revenue growth over the trailing twelve months (TTM), the picture was bleak. Except for one company that scraped by with a modest 10% growth, the rest were mired in negative territory, ranging from -10% to low single-digit positives. This isn't the kind of performance that screams "buy me at a premium."
Yet, despite this lukewarm growth, these stocks are trading at eye-watering TTM PE multiples of anywhere between 40x and 90x earnings.
It's a classic head-scratcher: What kind of growth expectations are baked into these prices?
Even if these companies managed to deliver 25-30%+ annual growth going forward, their stock prices might just tread water, offering little upside to new investors. Anything less, and we're looking at potential downside risks.
Case Study: Metro Brands - From IPO Darling to Reality Check
To illustrate, let's zoom in on the sector's biggest leader, Metro Brands.
The company went public in 2022 at a staggering 80x earnings, riding high on the wave of post-pandemic consumer recovery and expansion plans. For the first five quarters post-IPO, it delivered solid double-digit growth, culminating in a peak for both its stock price and earnings multiple around December 2023.
But what happened next? The growth trajectory turned erratic, oscillating between low single-digit increases and outright negatives.
Fast forward to today, and Metro Brands is still commanding a PE of nearly 90x on TTM earnings. This begs the question: Is the market overly optimistic about a quick turnaround, or is there something else at play, like brand loyalty or market share gains that aren't yet reflected in the numbers?
Key Takeaways for Investors
Diving into this analysis has reinforced some timeless investing principles, especially when eyeing beaten-down names or fresh IPOs:
Screen for Growth or Valuation Comfort: In volatile sectors like footwear, don't chase stocks solely based on past narratives. Always check if there's genuine growth momentum or if valuations provide a safety net. Right now, in this space, we find neither, high PEs without the growth to justify them.
Beware the Longevity of Earnings Growth in IPO-Bound Names: New listings often come with hype and short-term growth spurts, but sustainability is key. Metro Brands' post-IPO journey is a cautionary tale: What looks like a growth story can quickly fizzle if underlying fundamentals don't hold up.
In conclusion, while a high PE can indeed signal high growth expectations, it's not always a reliable precursor, sometimes it's just the market's wishful thinking. As investors, staying grounded in data and being skeptical of multiples detached from reality can help avoid costly pitfalls. If you're screening consumption stocks, broaden your lens beyond footwear for now, and always ask: What am I really paying for?
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