To the annoyance of some shareholders, Altra Industrial Motion (NASDAQ:AIMC) shares are down a considerable 55% in the last month. That drop has capped off a tough year for shareholders, with the share price down 47% in that time.
All else being equal, a share price drop should make a stock more attractive to potential investors. 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. 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 Altra Industrial Motion Have A Relatively High Or Low P/E For Its Industry?
Altra Industrial Motion's P/E of 8.06 indicates relatively low sentiment towards the stock. We can see in the image below that the average P/E (13.7) for companies in the machinery industry is higher than Altra Industrial Motion's P/E.
Its relatively low P/E ratio indicates that Altra Industrial Motion shareholders think it will struggle to do as well as other companies in its industry classification. Since the market seems unimpressed with Altra Industrial Motion, it's quite possible it could surprise on the upside. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and 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. And in that case, the P/E ratio itself will drop rather quickly. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
In the last year, Altra Industrial Motion grew EPS like Taylor Swift grew her fan base back in 2010; the 112% gain was both fast and well deserved. Even better, EPS is up 26% per year over three years. So you might say it really deserves to have an above-average P/E ratio.
Remember: P/E Ratios Don't Consider The Balance Sheet
Don't forget that the P/E ratio considers market capitalization. In other words, it does not consider any debt or cash that the company may have on the balance sheet. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.
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.
Altra Industrial Motion's Balance Sheet
Altra Industrial Motion has net debt worth a very significant 139% of its market capitalization. This level of debt justifies a relatively low P/E, so remain cognizant of the debt, if you're comparing it to other stocks.
The Bottom Line On Altra Industrial Motion's P/E Ratio
Altra Industrial Motion has a P/E of 8.1. That's below the average in the US market, which is 12.2. The company has a meaningful amount of debt on the balance sheet, but that should not eclipse the solid earnings growth. The low P/E ratio suggests current market expectations are muted, implying these levels of growth will not continue. Given Altra Industrial Motion's P/E ratio has declined from 17.9 to 8.1 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. 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 report on the analyst consensus forecasts could help you make a master move on this stock.
Of course you might be able to find a better stock than Altra Industrial Motion. So you may wish to see this free collection of other companies that have grown earnings strongly.
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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