Unfortunately for some shareholders, the Compagnie Générale des Établissements Michelin (EPA:ML) share price has dived 31% in the last thirty days. The recent drop has obliterated the annual return, with the share price now down 29% over that longer period.
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 Compagnie Générale des Établissements Michelin Have A Relatively High Or Low P/E For Its Industry?
Compagnie Générale des Établissements Michelin's P/E of 7.76 indicates some degree of optimism towards the stock. You can see in the image below that the average P/E (6.5) for companies in the auto components industry is lower than Compagnie Générale des Établissements Michelin's P/E.
Its relatively high P/E ratio indicates that Compagnie Générale des Établissements Michelin shareholders think it will perform better than other companies in its industry classification. Shareholders are clearly optimistic, but the future is always uncertain. So further research is always essential. 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. When earnings grow, the 'E' increases, over time. That means unless the share price increases, the P/E will reduce in a few years. Then, a lower P/E should attract more buyers, pushing the share price up.
Compagnie Générale des Établissements Michelin increased earnings per share by 4.2% last year. And earnings per share have improved by 12% annually, over the last five 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. 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.
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 Compagnie Générale des Établissements Michelin's Balance Sheet Tell Us?
Compagnie Générale des Établissements Michelin's net debt equates to 32% of its market capitalization. While that's enough to warrant consideration, it doesn't really concern us.
The Verdict On Compagnie Générale des Établissements Michelin's P/E Ratio
Compagnie Générale des Établissements Michelin trades on a P/E ratio of 7.8, which is below the FR market average of 14.1. EPS grew over the last twelve months, and debt levels are quite reasonable. If growth is sustainable over the long term, then the current P/E ratio may be a sign of good value. Given Compagnie Générale des Établissements Michelin's P/E ratio has declined from 11.2 to 7.8 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 invest in growth, this stock apparently offers limited promise, but the deep value investors may find the pessimism around this stock enticing.
Investors should be looking to buy stocks that the market is wrong about. If the reality for a company is not as bad as the P/E ratio indicates, then the share price should increase as the market realizes this. So this free report on the analyst consensus forecasts could help you make a master move on this stock.
Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.
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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