To the annoyance of some shareholders, Cirrus Logic (NASDAQ:CRUS) shares are down a considerable 37% in the last month. Looking back over the last year, the stock has been a solid performer, with a gain of 22%.
Assuming nothing else has changed, a lower share price makes a stock more 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). 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.
How Does Cirrus Logic's P/E Ratio Compare To Its Peers?
Cirrus Logic's P/E of 19.27 indicates relatively low sentiment towards the stock. We can see in the image below that the average P/E (22.9) for companies in the semiconductor industry is higher than Cirrus Logic's P/E.
Its relatively low P/E ratio indicates that Cirrus Logic shareholders think it will struggle to do as well as other companies in its industry classification. Many investors like to buy stocks when the market is pessimistic about their prospects. You should delve deeper. I like to check if company insiders have been buying or selling.
How Growth Rates Impact P/E Ratios
If earnings fall then in the future the 'E' will be lower. That means even if the current P/E is low, it will increase over time if the share price stays flat. Then, a higher P/E might scare off shareholders, pushing the share price down.
In the last year, Cirrus Logic grew EPS like Taylor Swift grew her fan base back in 2010; the 69% gain was both fast and well deserved. The sweetener is that the annual five year growth rate of 29% is also impressive. With that kind of growth rate we would generally expect a high P/E ratio. Regrettably, the longer term performance is poor, with EPS down -29% per year over 3 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. Theoretically, a business can improve its earnings (and produce a lower P/E in the future) by investing in growth. That means taking on debt (or spending its cash).
While growth expenditure doesn't always pay off, the point is that it is a good option to have; but one that the P/E ratio ignores.
So What Does Cirrus Logic's Balance Sheet Tell Us?
With net cash of US$355m, Cirrus Logic has a very strong balance sheet, which may be important for its business. Having said that, at 12% of its market capitalization the cash hoard would contribute towards a higher P/E ratio.
The Bottom Line On Cirrus Logic's P/E Ratio
Cirrus Logic trades on a P/E ratio of 19.3, which is above its market average of 12.7. Its net cash position is the cherry on top of its superb EPS growth. So based on this analysis we'd expect Cirrus Logic to have a high P/E ratio. What can be absolutely certain is that the market has become significantly less optimistic about Cirrus Logic over the last month, with the P/E ratio falling from 30.7 back then to 19.3 today. For those who prefer to invest with the flow of momentum, that might be a bad sign, but for a contrarian, it may signal opportunity.
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 visual report on analyst forecasts could hold the key to an excellent investment decision.
Of course you might be able to find a better stock than Cirrus Logic. 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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