Unfortunately for some shareholders, the Atlantica Yield (NASDAQ:AY) share price has dived 31% in the last thirty days. Indeed, the recent drop has reduced the annual gain to a relatively sedate 8.1% over the last twelve months.
All else being equal, a share price drop should make a stock more attractive to potential investors. 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). A high P/E ratio means that investors have a high expectation about future growth, while a low P/E ratio means they have low expectations about future growth.
Does Atlantica Yield Have A Relatively High Or Low P/E For Its Industry?
Atlantica Yield's P/E of 34.16 indicates some degree of optimism towards the stock. The image below shows that Atlantica Yield has a higher P/E than the average (29.6) P/E for companies in the renewable energy industry.
Atlantica Yield's P/E tells us that market participants think the company will perform better than its industry peers, going forward. Clearly the market expects growth, but it isn't guaranteed. So investors should delve deeper. I like to check if company insiders have been buying or selling.
How Growth Rates Impact P/E Ratios
P/E ratios primarily reflect market expectations around earnings growth rates. Earnings growth means that in the future the 'E' will be higher. That means unless the share price increases, the P/E will reduce in a few years. And as that P/E ratio drops, the company will look cheap, unless its share price increases.
Notably, Atlantica Yield grew EPS by a whopping 48% in the last year.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
The 'Price' in P/E reflects the market capitalization of the company. So it won't reflect the advantage of cash, or disadvantage of debt. Theoretically, a business can improve its earnings (and produce a lower P/E in the future) by investing in growth. That means taking on debt (or spending its cash).
Such spending might be good or bad, overall, but the key point here is that you need to look at debt to understand the P/E ratio in context.
Atlantica Yield's Balance Sheet
Atlantica Yield has net debt worth a very significant 240% of its market capitalization. This level of debt justifies a relatively low P/E, so remain cognizant of the debt, if you're comparing it to other stocks.
The Verdict On Atlantica Yield's P/E Ratio
Atlantica Yield trades on a P/E ratio of 34.2, which is above its market average of 13.3. Its meaningful level of debt should warrant a lower P/E ratio, but the fast EPS growth is a positive. So it seems likely the market is overlooking the debt because of the fast earnings growth. Given Atlantica Yield's P/E ratio has declined from 49.8 to 34.2 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 prefer to invest with the flow of momentum, that might be a bad sign, but for a contrarian, it may signal opportunity.
Investors should be looking to buy stocks that the market is wrong about. People often underestimate remarkable growth -- so investors can make money when fast growth is not fully appreciated. So this free visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.
Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.
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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