Why I think the Halfords share price is rising. And it’s risky

Halfords share price is rising fast. But, here’s why I think it could be risky, says this Fool.

| More on:

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

The Halfords (LSE: HFD) share price has exploded, up 17% over the last month. Indeed, shares in the automotive, leisure, and cycling product retailer leave the FTSE All-Share‘s comparative 0.75% return looking fairly dismal.

In addition, many analysts appear to be positive about the company as more people cycling means higher revenues. I’m seeing quite a few buy recommendations across the Internet and these likely explain the recent good stock performance.

However, looking more closely, many of these analysts are valuing the stock using forward price-to-earnings (P/E) ratios. In my mind, this is nonsensical and makes me question the sanity of the share price, especially when car use is currently low.

The problem with forward P/E ratios

A forward P/E ratio is calculated by dividing the current known price by next year’s predicted earnings. I’ve seen forward P/E ratios for the Halfords share price that vary from 9 to 17. And there’s probably more outliers out there too.

The problem, of course, is that what Halfords will earn next year is anybody’s guess. And that’s all it is. The forward P/E ratio is based on an estimate of Halfords’ future business. And, with a huge variance from one analyst to the next.

Now, you could argue that these forward P/Es are all relatively low, especially when compared with the specialist retail sector’s average P/E of around 24. So, what’s the problem?

The problem is Halfords’ actual recorded figures. Taking an average of the last five years of earnings for the company, I calculated average normalised earnings of 28p per share. This figure gives an average P/E of around 6.8, lower than all the forward P/E ratios I’ve seen reported. 

Consequently, it appears that, far from being confident in Halfords’ future, analysts are expecting earnings to drop. 

Halfords share price will follow its earnings

The problem, of course, with lower earnings from one year to the next is the share price will likely follow. And Halfords has reported a declining trend in earnings over the last five years that parallels the share price trend.

Although turnover has increased each year since 2016, operating profit has dropped year on year. Sadly for Halfords, it looked like it was about to buck this trend this year when Covid-19 struck. Dividend payments on top of closure costs resulted in an overall loss for the year.

On the bright side, the uptake in cycling during lockdown helped to offset the impact of lowering car use on Halfords’ 2020 finances. But the motoring business is higher margin than cycling and Halfords will need to adjust its business model to fit.

When combined with a troubling economic outlook overall, there is significant uncertainty about Halfords’ immediate future.

At current levels, Halfords shares aren’t badly priced. But, buying a stock based on a P/E ratio using unknown future earnings is highly risky. I think Halfords will continue its downward trend, certainly in the short term. So, for the moment, I’m out.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Rachael FitzGerald-Finch has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

More on Investing Articles

Investing Articles

Up 26%, can the BT share price really push higher still?

The BT share price has surged on several catalysts in 2024, but there’s evidence to suggest that the stock could…

Read more »

Man writing 'now' having crossed out 'later', 'tomorrow' and 'next week'
Investing Articles

What are the best dividend shares to buy right now?

As shares in B&M European Value Retail have fallen, the dividend yield has reached a 10-year high. Should investors be…

Read more »

Surprised Black girl holding teddy bear toy on Christmas
Investing Articles

My favourite FTSE 100 passive income stock that keeps the Christmas coffers full

The holiday season is expensive and can leave many consumers struggling to make ends meet. Here’s how I use a…

Read more »

Investing Articles

The latest growth forecasts suggest the Glencore share price will hit 555p!

Harvey Jones has been disappointed by the performance of the Glencore share price since he bought the commodity stock last…

Read more »

Dividend Shares

A closer look at the 11% dividend yield forecast for Phoenix Group shares

Phoenix Group shares have one of the highest dividend yields in the FTSE 100 index today. Could this be a…

Read more »

Investing Articles

If I’d put £25,000 into the FTSE 350 at the start of 2024, here’s how much I’d have today!

Many FTSE shares have rebounded this year as interest rates look set to keep heading lower and market appetite for…

Read more »

Investing Articles

Up 40%, but experts forecast the easyJet share price could soon hit 664p! Time to buy?

The easyJet share price has been flying lately and stock analysts are predicting more fun to come. But there's only…

Read more »

Storytelling image of a multiethnic senior couple in love - Elderly married couple dating outdoors, love emotions and feelings
Investing Articles

Worried about tax raids? Here’s how I’m targeting a £44,526 passive income with shares

Investing in a Self-Invested Personal Pension (SIPP) or Individual Savings Account (ISA) can supercharge one's passive income, says Royston Wild.

Read more »