Unfortunately for some shareholders, the AB Fagerhult (STO:FAG) share price has dived 41% in the last thirty days. That drop has capped off a tough year for shareholders, with the share price down 56% in that time.
Assuming nothing else has changed, a lower share price makes a stock more 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). The implication here is that long term investors have an opportunity when expectations of a company are too low. One way to gauge market expectations of a stock 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.
How Does AB Fagerhult's P/E Ratio Compare To Its Peers?
We can tell from its P/E ratio of 10.05 that sentiment around AB Fagerhult isn't particularly high. If you look at the image below, you can see AB Fagerhult has a lower P/E than the average (17.5) in the electrical industry classification.
AB Fagerhult's P/E tells us that market participants think it will not fare as well as its peers in the same industry. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and selling.
How Growth Rates Impact P/E Ratios
Companies that shrink earnings per share quickly will rapidly decrease the 'E' in the equation. Therefore, even if you pay a low multiple of earnings now, that multiple will become higher in the future. Then, a higher P/E might scare off shareholders, pushing the share price down.
AB Fagerhult's earnings per share fell by 25% in the last twelve months. But it has grown its earnings per share by 7.6% per year over the last five years.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
Don't forget that the P/E ratio considers market capitalization. That means it doesn't take debt or cash into account. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
While growth expenditure doesn't always pay off, the point is that it is a good option to have; but one that the P/E ratio ignores.
So What Does AB Fagerhult's Balance Sheet Tell Us?
Net debt is 50% of AB Fagerhult's market cap. While it's worth keeping this in mind, it isn't a worry.
The Verdict On AB Fagerhult's P/E Ratio
AB Fagerhult has a P/E of 10.1. That's below the average in the SE market, which is 13.8. The debt levels are not a major concern, but the lack of EPS growth is likely weighing on sentiment. Given AB Fagerhult's P/E ratio has declined from 17.1 to 10.1 in the last month, we know for sure that the market is significantly less confident about the business today, than it was back then. For those who don't like to trade against momentum, that could be a warning sign, but a contrarian investor might want to take a closer look.
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 AB Fagerhult. 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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