Unfortunately for some shareholders, the Cleveland-Cliffs (NYSE:CLF) share price has dived 55% in the last thirty days. And that drop will have no doubt have some shareholders concerned that the 63% share price decline, over the last year, has turned them into bagholders. For those wondering, a bagholder is someone who keeps holding a losing stock indefinitely, without taking the time to consider its prospects carefully, going forward.
Assuming nothing else has changed, a lower share price makes a stock more attractive to potential buyers. 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). So, on certain occasions, long term focussed investors try to take advantage of pessimistic expectations to buy shares at a better price. 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.
How Does Cleveland-Cliffs's P/E Ratio Compare To Its Peers?
Cleveland-Cliffs's P/E of 3.20 indicates relatively low sentiment towards the stock. If you look at the image below, you can see Cleveland-Cliffs has a lower P/E than the average (7.5) in the metals and mining industry classification.
Cleveland-Cliffs's P/E tells us that market participants think it will not fare as well as its peers in the same industry. Since the market seems unimpressed with Cleveland-Cliffs, it's quite possible it could surprise on the upside. You should delve deeper. I like to check if company insiders have been buying or selling.
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. 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. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
Cleveland-Cliffs shrunk earnings per share by 70% over the last year. But over the longer term (3 years), earnings per share have increased by 29%. And EPS is down 32% a year, over the last 5 years. This could justify a pessimistic P/E.
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. In other words, it does not consider any debt or cash that the company may have on the balance sheet. 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.
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.
Cleveland-Cliffs's Balance Sheet
Cleveland-Cliffs's net debt is considerable, at 130% of its market cap. This is a relatively high level of debt, so the stock probably deserves a relatively low P/E ratio. Keep that in mind when comparing it to other companies.
The Verdict On Cleveland-Cliffs's P/E Ratio
Cleveland-Cliffs trades on a P/E ratio of 3.2, which is below the US market average of 12.2. Given meaningful debt, and a lack of recent growth, the market looks to be extrapolating this recent performance; reflecting low expectations for the future. Given Cleveland-Cliffs's P/E ratio has declined from 7.1 to 3.2 in the last month, we know for sure that the market is more worried 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 deep value investors this stock might justify some research.
Investors have an opportunity when market expectations about a stock are wrong. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. So this free report on the analyst consensus forecasts could help you make a master move on this stock.
But note: Cleveland-Cliffs 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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