The Butterfly Gandhimathi Appliances (NSE:BUTTERFLY) share price has done well in the last month, posting a gain of 30%. But shareholders may not all be feeling jubilant, since the share price is still down 25% in the last year.
All else being equal, a sharp share price increase should make a stock less 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 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). 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 Butterfly Gandhimathi Appliances Have A Relatively High Or Low P/E For Its Industry?
We can tell from its P/E ratio of 28.13 that there is some investor optimism about Butterfly Gandhimathi Appliances. You can see in the image below that the average P/E (22.8) for companies in the consumer durables industry is lower than Butterfly Gandhimathi Appliances's P/E.
Its relatively high P/E ratio indicates that Butterfly Gandhimathi Appliances shareholders think it will perform better than other companies in its industry classification. Clearly the market expects growth, but it isn't guaranteed. 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
Generally speaking the rate of earnings growth has a profound impact on a company's P/E multiple. That's because companies that grow earnings per share quickly will rapidly increase the 'E' in the equation. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. Then, a lower P/E should attract more buyers, pushing the share price up.
Butterfly Gandhimathi Appliances increased earnings per share by a whopping 31% last year. And its annual EPS growth rate over 5 years is 7.6%. I'd therefore be a little surprised if its P/E ratio was not relatively high.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
Don't forget that the P/E ratio considers market capitalization. Thus, the metric does not reflect cash or debt held by the company. 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).
Spending on growth might be good or bad a few years later, but the point is that the P/E ratio does not account for the option (or lack thereof).
How Does Butterfly Gandhimathi Appliances's Debt Impact Its P/E Ratio?
Net debt is 47% of Butterfly Gandhimathi Appliances's market cap. While it's worth keeping this in mind, it isn't a worry.
The Verdict On Butterfly Gandhimathi Appliances's P/E Ratio
Butterfly Gandhimathi Appliances has a P/E of 28.1. That's higher than the average in its market, which is 13.5. 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. What we know for sure is that investors have become much more excited about Butterfly Gandhimathi Appliances recently, since they have pushed its P/E ratio from 21.6 to 28.1 over the last month. For those who prefer to invest with the flow of momentum, that might mean it's time to put the stock on a watchlist, or research it. But the contrarian may see it as a missed opportunity.
When the market is wrong about a stock, it gives savvy investors an opportunity. 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 visual report on analyst forecasts could hold the key to an excellent investment decision.
You might be able to find a better buy than Butterfly Gandhimathi Appliances. 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).
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If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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. Thank you for reading.