To the annoyance of some shareholders, Green Brick Partners (NASDAQ:GRBK) shares are down a considerable 33% in the last month. The recent drop has obliterated the annual return, with the share price now down 15% over that longer period.
Assuming nothing else has changed, a lower share price makes a stock more 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. 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.
How Does Green Brick Partners's P/E Ratio Compare To Its Peers?
Green Brick Partners's P/E of 6.44 indicates relatively low sentiment towards the stock. We can see in the image below that the average P/E (7.9) for companies in the consumer durables industry is higher than Green Brick Partners's P/E.
Green Brick Partners'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 Green Brick Partners, it's quite possible it could surprise on the upside. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.
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. That's because companies that grow earnings per share quickly will rapidly increase the 'E' in the equation. And in that case, the P/E ratio itself will drop rather quickly. And as that P/E ratio drops, the company will look cheap, unless its share price increases.
It's great to see that Green Brick Partners grew EPS by 14% in the last year. And earnings per share have improved by 34% annually, over the last three years. With that performance, you might expect an above average P/E ratio. But earnings per share are down 19% per year over the last five years.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
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. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.
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 Green Brick Partners's Balance Sheet Tell Us?
Net debt totals 54% of Green Brick Partners's market cap. If you want to compare its P/E ratio to other companies, you should absolutely keep in mind it has significant borrowings.
The Bottom Line On Green Brick Partners's P/E Ratio
Green Brick Partners trades on a P/E ratio of 6.4, which is below the US market average of 13.0. The company may have significant debt, but EPS growth was good last year. If it continues to grow, then the current low P/E may prove to be unjustified. Given Green Brick Partners's P/E ratio has declined from 9.6 to 6.4 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 to invest with the flow of momentum, that might be a bad sign, but for deep value investors this stock might justify some research.
Investors should be looking to buy stocks that the market is wrong about. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. So this free report on the analyst consensus forecasts could help you make a master move on this stock.
You might be able to find a better buy than Green Brick Partners. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
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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