Unfortunately for some shareholders, the Clean Seas Seafood (ASX:CSS) share price has dived 30% in the last thirty days. Indeed the recent decline has arguably caused some bitterness for shareholders who have held through the 47% drop over twelve months.
Assuming nothing else has changed, a lower share price makes a stock more 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 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 implies that investors have high expectations of what a company can achieve compared to a company with a low P/E ratio.
Does Clean Seas Seafood Have A Relatively High Or Low P/E For Its Industry?
We can tell from its P/E ratio of 4.11 that sentiment around Clean Seas Seafood isn't particularly high. The image below shows that Clean Seas Seafood has a lower P/E than the average (17.1) P/E for companies in the food industry.
Its relatively low P/E ratio indicates that Clean Seas Seafood shareholders think it will struggle to do as well as other companies in its industry classification. Many investors like to buy stocks when the market is pessimistic about their prospects. You 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. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. 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.
In the last year, Clean Seas Seafood grew EPS like Taylor Swift grew her fan base back in 2010; the 258% gain was both fast and well deserved.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
Don't forget that the P/E ratio considers market capitalization. Thus, the metric does not reflect cash or debt held by the company. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
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.
How Does Clean Seas Seafood's Debt Impact Its P/E Ratio?
Clean Seas Seafood has net debt worth just 8.9% of its market capitalization. So it doesn't have as many options as it would with net cash, but its debt would not have much of an impact on its P/E ratio.
The Bottom Line On Clean Seas Seafood's P/E Ratio
Clean Seas Seafood's P/E is 4.1 which is below average (15.9) in the AU market. The company does have a little debt, and EPS growth was good last year. If it continues to grow, then the current low P/E may prove to be unjustified. What can be absolutely certain is that the market has become more pessimistic about Clean Seas Seafood over the last month, with the P/E ratio falling from 5.9 back then to 4.1 today. For those who prefer invest in growth, this stock apparently offers limited promise, but the deep value investors may find the pessimism around this stock enticing.
Investors should be looking to buy stocks that the market is wrong about. If the reality for a company is not as bad as the P/E ratio indicates, then the share price should increase as the market realizes this. Although we don't have analyst forecasts shareholders might want to examine this detailed historical graph of earnings, revenue and cash flow.
You might be able to find a better buy than Clean Seas Seafood. 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 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.
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