IF Bancorp (NASDAQ:IROQ) shares have retraced a considerable in the last month. But there's still good reason for shareholders to be content; the stock has gained 11% in the last 90 days. Looking back over the last year, the stock has been a solid performer, with a gain of 19%.
Assuming no other changes, a sharply higher share price makes a stock less attractive to potential buyers. While the market sentiment towards a stock is very changeable, in the long run, the share price will tend to move in the same direction as earnings per share. The implication here is that deep value investors might steer clear when expectations of a company are too high. 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.
Does IF Bancorp Have A Relatively High Or Low P/E For Its Industry?
IF Bancorp's P/E of 21.71 indicates some degree of optimism towards the stock. As you can see below, IF Bancorp has a higher P/E than the average company (14.6) in the mortgage industry.
That means that the market expects IF Bancorp will outperform other companies in its industry. Shareholders are clearly optimistic, but the future is always uncertain. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.
How Growth Rates Impact P/E Ratios
Probably the most important factor in determining what P/E a company trades on is the earnings growth. Earnings growth means that in the future the 'E' will be higher. And in that case, the P/E ratio itself will drop rather quickly. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
IF Bancorp's 136% EPS improvement over the last year was like bamboo growth after rain; rapid and impressive.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
The 'Price' in P/E reflects the market capitalization of the company. That means it doesn't take debt or cash into account. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.
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.
So What Does IF Bancorp's Balance Sheet Tell Us?
IF Bancorp's net debt equates to 29% of its market capitalization. While it's worth keeping this in mind, it isn't a worry.
The Verdict On IF Bancorp's P/E Ratio
IF Bancorp trades on a P/E ratio of 21.7, which is above its market average of 18.9. The company is not overly constrained by its modest debt levels, and its recent EPS growth is nothing short of stand-out. So on this analysis a high P/E ratio seems reasonable. Given IF Bancorp's P/E ratio has declined from 21.7 to 21.7 in the last month, we know for sure that the market is 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. Although we don't have analyst forecasts you could get a better understanding of its growth by checking out this more detailed historical graph of earnings, revenue and cash flow.
But note: IF Bancorp may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio 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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