The Elders (ASX:ELD) share price has done well in the last month, posting a gain of 36%. The full year gain of 33% is pretty reasonable, too.
Assuming no other changes, a sharply higher share price makes a stock less attractive to potential buyers. 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 implies that investors have high expectations of what a company can achieve compared to a company with a low P/E ratio.
Does Elders Have A Relatively High Or Low P/E For Its Industry?
We can tell from its P/E ratio of 13.24 that sentiment around Elders isn't particularly high. We can see in the image below that the average P/E (21.0) for companies in the food industry is higher than Elders's P/E.
Its relatively low P/E ratio indicates that Elders 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. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and selling.
How Growth Rates Impact P/E Ratios
When earnings fall, the 'E' decreases, over time. 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.
Elders saw earnings per share decrease by 7.7% last year. But over the longer term (5 years) earnings per share have increased by 12%. And EPS is down 3.0% a year, over the last 3 years. So you wouldn't expect a very high P/E.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. That means it doesn't take debt or cash into account. In theory, a company can lower its future P/E ratio by using cash or debt to invest in 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).
Elders's Balance Sheet
Elders has net debt worth just 7.2% of its market capitalization. So it doesn't have as many options as it would with net cash, but its debt would not have much of an impact on its P/E ratio.
The Verdict On Elders's P/E Ratio
Elders has a P/E of 13.2. That's below the average in the AU market, which is 18.8. With only modest debt, it's likely the lack of EPS growth at least partially explains the pessimism implied by the P/E ratio. What we know for sure is that investors have become more excited about Elders recently, since they have pushed its P/E ratio from 9.7 to 13.2 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.
When the market is wrong about a stock, it gives savvy investors an opportunity. 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 report on the analyst consensus forecasts could help you make a master move on this stock.
But note: Elders 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 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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