The Motley Fool

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

Image source: Getty Images.

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.

5G is here – and shares of this ‘sleeping giant’ could be a great way for you to potentially profit!

According to one leading industry firm, the 5G boom could create a global industry worth US$12.3 TRILLION out of thin air…

And if you click here we’ll show you something that could be key to unlocking 5G’s full potential...

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.

“This Stock Could Be Like Buying Amazon in 1997”

I'm sure you'll agree that's quite the statement from Motley Fool Co-Founder Tom Gardner.

But since our US analyst team first recommended shares in this unique tech stock back in 2016, the value has soared.

What's more, we firmly believe there's still plenty of upside in its future. In fact, even throughout the current coronavirus crisis, its performance has been beating Wall St expectations.

And right now, we're giving you a chance to discover exactly what has got our analysts all fired up about this niche industry phenomenon, in our FREE special report, A Top US Share From The Motley Fool.

Click here to claim your copy now — and we’ll tell you the name of this Top US Share… free of charge!

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.

Where to invest £1,000 right now

Renowned stock-picker Mark Rogers and his select team of expert analysts at The Motley Fool UK have just revealed 6 "Best Buy" shares that they believe UK investors should consider buying NOW.

So if you’re looking for more top stock ideas to try and best position your portfolio in this market, then I have some good news for your today -- because we're offering a full 33% off your first year of membership to our flagship share-tipping service, backed by our 'no quibbles' 30-day subscription fee refund guarantee.

Simply enter your email address below to discover how you can take advantage of this.

I would like to receive emails from you about product information and offers from The Fool and its business partners. Each of these emails will provide a link to unsubscribe from future emails. More information about how The Fool collects, stores, and handles personal data is available in its Privacy Statement.