American Vanguard (NYSE:AVD) shareholders are no doubt pleased to see that the share price has had a great month, posting a 33% gain, recovering from prior weakness. The full year gain of 30% is pretty reasonable, too.
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. 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 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 American Vanguard's P/E Ratio Compare To Its Peers?
We can tell from its P/E ratio of 31.08 that there is some investor optimism about American Vanguard. The image below shows that American Vanguard has a higher P/E than the average (21.0) P/E for companies in the chemicals industry.
American Vanguard's P/E tells us that market participants think the company will perform better than its industry peers, going forward. The market is optimistic about the future, but that doesn't guarantee future growth. So further research is always essential. I often monitor director buying and 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. 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. And as that P/E ratio drops, the company will look cheap, unless its share price increases.
American Vanguard saw earnings per share decrease by 30% last year. But over the longer term (5 years) earnings per share have increased by 39%.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
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. 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.
So What Does American Vanguard's Balance Sheet Tell Us?
Net debt is 29% of American Vanguard's market cap. While it's worth keeping this in mind, it isn't a worry.
The Bottom Line On American Vanguard's P/E Ratio
American Vanguard has a P/E of 31.1. That's higher than the average in its market, which is 18.9. With modest debt but no EPS growth in the last year, it's fair to say the P/E implies some optimism about future earnings, from the market. What we know for sure is that investors have become much more excited about American Vanguard recently, since they have pushed its P/E ratio from 23.4 to 31.1 over the last month. If you like to buy stocks that have recently impressed the market, then this one might be a candidate; but if you prefer to invest when there is 'blood in the streets', then you may feel the opportunity has passed.
Investors should be looking to buy stocks that the market is wrong about. 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 visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.
Of course you might be able to find a better stock than American Vanguard. 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 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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