Biffa (LON:BIFF) shares have had a really impressive month, gaining 30%, after some slippage. Unfortunately, the full year gain of 6.2% wasn't so sweet.
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. 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 Biffa's P/E Ratio Compare To Its Peers?
We can tell from its P/E ratio of 35.83 that there is some investor optimism about Biffa. As you can see below, Biffa has a higher P/E than the average company (18.0) in the commercial services industry.
Biffa's P/E tells us that market participants think the company will perform better than its industry peers, going forward. Clearly the market expects growth, but it isn't guaranteed. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.
How Growth Rates Impact P/E Ratios
P/E ratios primarily reflect market expectations around earnings growth rates. Earnings growth means that in the future the 'E' will be higher. 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.
Biffa saw earnings per share decrease by 42% last year.
Remember: P/E Ratios Don't Consider The Balance Sheet
Don't forget that the P/E ratio considers market capitalization. Thus, the metric does not reflect cash or debt held by the company. 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.
Spending on growth might be good or bad a few years later, but the point is that the P/E ratio does not account for the option (or lack thereof).
Is Debt Impacting Biffa's P/E?
Biffa's net debt equates to 33% of its market capitalization. While that's enough to warrant consideration, it doesn't really concern us.
The Verdict On Biffa's P/E Ratio
Biffa's P/E is 35.8 which is above average (16.0) in its market. 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 is very clear is that the market has become significantly more optimistic about Biffa over the last month, with the P/E ratio rising from 27.5 back then to 35.8 today. 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.
When the market is wrong about a stock, it gives savvy investors an opportunity. People often underestimate remarkable growth -- so investors can make money when fast growth is not fully appreciated. So this free report on the analyst consensus forecasts could help you make a master move on this stock.
But note: Biffa 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).
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