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Does Chicago Rivet & Machine Co.'s (NYSEMKT:CVR) P/E Ratio Signal A Buying Opportunity?

To the annoyance of some shareholders, Chicago Rivet & Machine (NYSEMKT:CVR) shares are down a considerable in the last month. The recent drop has obliterated the annual return, with the share price now down 11% over that longer period.

Assuming no other changes, a sharply higher share price makes a stock less 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 some would prefer to hold off buying when there is a lot of optimism towards a stock. 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.

Check out our latest analysis for Chicago Rivet & Machine

Does Chicago Rivet & Machine Have A Relatively High Or Low P/E For Its Industry?

Chicago Rivet & Machine's P/E is 23.44. As you can see below Chicago Rivet & Machine has a P/E ratio that is fairly close for the average for the machinery industry, which is 21.9.

AMEX:CVR Price Estimation Relative to Market, December 5th 2019
AMEX:CVR Price Estimation Relative to Market, December 5th 2019

Its P/E ratio suggests that Chicago Rivet & Machine shareholders think that in the future it will perform about the same as other companies in its industry classification. So if Chicago Rivet & Machine actually outperforms its peers going forward, that should be a positive for the share price. Further research into factors such as insider buying and selling, could help you form your own view on whether that is likely.

How Growth Rates Impact P/E Ratios

When earnings fall, the 'E' decreases, over time. Therefore, even if you pay a low multiple of earnings now, that multiple will become higher in the future. So while a stock may look cheap based on past earnings, it could be expensive based on future earnings.

Chicago Rivet & Machine's earnings per share fell by 54% in the last twelve months. And EPS is down 13% a year, over the last 5 years. This growth rate might warrant a below average P/E ratio.

Remember: P/E Ratios Don't Consider The Balance Sheet

It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. Thus, the metric does not reflect cash or debt held by the company. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.

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 Chicago Rivet & Machine's P/E?

Chicago Rivet & Machine has net cash of US$7.3m. This is fairly high at 28% of its market capitalization. That might mean balance sheet strength is important to the business, but should also help push the P/E a bit higher than it would otherwise be.

The Bottom Line On Chicago Rivet & Machine's P/E Ratio

Chicago Rivet & Machine has a P/E of 23.4. That's higher than the average in its market, which is 18.2. The recent drop in earnings per share would make some investors cautious, but the healthy balance sheet means the company retains potential for future growth. If fails to eventuate, the current high P/E could prove to be temporary, as the share price falls. Given Chicago Rivet & Machine's P/E ratio has declined from 23.4 to 23.4 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. 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. Although we don't have analyst forecasts you might want to assess this data-rich visualization of earnings, revenue and cash flow.

But note: Chicago Rivet & Machine 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 editorial-team@simplywallst.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.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.