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DLH Holdings (NASDAQ:DLHC) shareholders are no doubt pleased to see that the share price has had a great month, posting a 46% gain, recovering from prior weakness. But shareholders may not all be feeling jubilant, since the share price is still down 23% in the last year.
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. 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). Investors have optimistic expectations of companies with higher P/E ratios, compared to companies with lower P/E ratios.
How Does DLH Holdings's P/E Ratio Compare To Its Peers?
We can tell from its P/E ratio of 11.13 that sentiment around DLH Holdings isn't particularly high. If you look at the image below, you can see DLH Holdings has a lower P/E than the average (14.1) in the professional services industry classification.
DLH Holdings's P/E tells us that market participants think it will not fare as well as its peers in the same industry. Since the market seems unimpressed with DLH Holdings, it's quite possible it could surprise on the upside. You should delve deeper. I like to check if company insiders have been buying or selling.
How Growth Rates Impact P/E Ratios
Earnings growth rates have a big influence on P/E ratios. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. That means unless the share price increases, the P/E will reduce in a few years. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.
DLH Holdings shrunk earnings per share by 20% over the last year. But over the longer term (3 years), earnings per share have increased by 5.3%. And it has shrunk its earnings per share by 5.1% per year over the last five years. This growth rate might warrant a below average P/E ratio.
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. 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 expenditure might be good or bad, in the long term, but the point here is that the balance sheet is not reflected by this ratio.
So What Does DLH Holdings's Balance Sheet Tell Us?
DLH Holdings has net debt worth 93% of its market capitalization. This is enough debt that you'd have to make some adjustments before using the P/E ratio to compare it to a company with net cash.
The Verdict On DLH Holdings's P/E Ratio
DLH Holdings has a P/E of 11.1. That's below the average in the US market, which is 13.2. When you consider that the company has significant debt, and didn't grow EPS last year, it isn't surprising that the market has muted expectations. What we know for sure is that investors have become more excited about DLH Holdings recently, since they have pushed its P/E ratio from 7.6 to 11.1 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. 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.
But note: DLH Holdings 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 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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