To the annoyance of some shareholders, Cooper Tire & Rubber (NYSE:CTB) shares are down a considerable 30% in the last month. That drop has capped off a tough year for shareholders, with the share price down 34% 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). 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 Cooper Tire & Rubber Have A Relatively High Or Low P/E For Its Industry?
Cooper Tire & Rubber's P/E of 10.03 indicates relatively low sentiment towards the stock. We can see in the image below that the average P/E (11.8) for companies in the auto components industry is higher than Cooper Tire & Rubber's P/E.
This suggests that market participants think Cooper Tire & Rubber will underperform other companies in its industry. Many investors like to buy stocks when the market is pessimistic about their prospects. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.
How Growth Rates Impact P/E Ratios
When earnings fall, the 'E' decreases, over time. That means even if the current P/E is low, it will increase over time if the share price stays flat. A higher P/E should indicate the stock is expensive relative to others -- and that may encourage shareholders to sell.
It's nice to see that Cooper Tire & Rubber grew EPS by a stonking 26% in the last year. But earnings per share are down 11% per year over the last five years.
Remember: P/E Ratios Don't Consider The Balance Sheet
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. So it won't reflect the advantage of cash, or disadvantage of debt. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
Such expenditure might be good or bad, in the long term, but the point here is that the balance sheet is not reflected by this ratio.
So What Does Cooper Tire & Rubber's Balance Sheet Tell Us?
The extra options and safety that comes with Cooper Tire & Rubber's US$61m net cash position means that it deserves a higher P/E than it would if it had a lot of net debt.
The Bottom Line On Cooper Tire & Rubber's P/E Ratio
Cooper Tire & Rubber's P/E is 10.0 which is below average (13.3) in the US market. The net cash position gives plenty of options to the business, and the recent improvement in EPS is good to see. The below average P/E ratio suggests that market participants don't believe the strong growth will continue. Because analysts are predicting more growth in the future, one might have expected to see a higher P/E ratio. You can take a closer look at the fundamentals, here. Given Cooper Tire & Rubber's P/E ratio has declined from 14.3 to 10.0 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 don't like to trade against momentum, that could be a warning sign, but a contrarian investor might want to take a closer look.
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. So this free visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.
You might be able to find a better buy than Cooper Tire & Rubber. 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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