Unfortunately for some shareholders, the Basic-Fit (AMS:BFIT) share price has dived 52% in the last thirty days. That drop has capped off a tough year for shareholders, with the share price down 45% in that time.
All else being equal, a share price drop should make a stock more attractive to potential investors. 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 long term investors have an opportunity when expectations of a company are too low. Perhaps the simplest way to get a read on investors' expectations of a business 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 Basic-Fit Have A Relatively High Or Low P/E For Its Industry?
We can tell from its P/E ratio of 79.96 that there is some investor optimism about Basic-Fit. As you can see below, Basic-Fit has a much higher P/E than the average company (12.8) in the hospitality industry.
That means that the market expects Basic-Fit will outperform other companies in its industry. The market is optimistic about the future, but that doesn't guarantee future growth. So investors should delve deeper. I like to check if company insiders have been buying or selling.
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. Then, a lower P/E should attract more buyers, pushing the share price up.
It's great to see that Basic-Fit grew EPS by 18% in the last year.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. That means it doesn't take debt or cash into account. The exact same company would hypothetically deserve a higher P/E ratio if it had a strong balance sheet, than if it had a weak one with lots of debt, because a cashed up company can spend on growth.
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.
Is Debt Impacting Basic-Fit's P/E?
Net debt totals 51% of Basic-Fit's market cap. This is a reasonably significant level of debt -- all else being equal you'd expect a much lower P/E than if it had net cash.
The Verdict On Basic-Fit's P/E Ratio
Basic-Fit's P/E is 80.0 which suggests the market is more focussed on the future opportunity rather than the current level of earnings. While the meaningful level of debt does limit its options, it has achieved solid growth over the last year. But if growth falters, the relatively high P/E ratio may prove to be unjustified. What can be absolutely certain is that the market has become significantly less optimistic about Basic-Fit over the last month, with the P/E ratio falling from 167.5 back then to 80.0 today. 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.
When the market is wrong about a stock, it gives savvy investors an opportunity. People often underestimate remarkable growth -- so investors can make money when fast growth is not fully appreciated. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.
But note: Basic-Fit 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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