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Unfortunately for some shareholders, the Heritage-Crystal Clean (NASDAQ:HCCI) share price has dived 33% in the last thirty days. Indeed the recent decline has arguably caused some bitterness for shareholders who have held through the 35% drop over twelve months.
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. 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 Heritage-Crystal Clean Have A Relatively High Or Low P/E For Its Industry?
We can tell from its P/E ratio of 49.18 that there is some investor optimism about Heritage-Crystal Clean. The image below shows that Heritage-Crystal Clean has a higher P/E than the average (21.7) P/E for companies in the commercial services industry.
Heritage-Crystal Clean's P/E tells us that market participants think the company will perform better than its industry peers, going forward. The market is optimistic about the future, but that doesn't guarantee future growth. So further research is always essential. I often monitor director buying and selling.
How Growth Rates Impact P/E Ratios
P/E ratios primarily reflect market expectations around earnings growth rates. When earnings grow, the 'E' increases, over time. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. Then, a lower P/E should attract more buyers, pushing the share price up.
Heritage-Crystal Clean shrunk earnings per share by 44% over the last year. But it has grown its earnings per share by 11% per year over the last three years.
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. In other words, it does not consider any debt or cash that the company may have on the balance sheet. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.
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.
How Does Heritage-Crystal Clean's Debt Impact Its P/E Ratio?
Since Heritage-Crystal Clean holds net cash of US$31m, it can spend on growth, justifying a higher P/E ratio than otherwise.
The Bottom Line On Heritage-Crystal Clean's P/E Ratio
Heritage-Crystal Clean has a P/E of 49.2. That's significantly higher than the average in its market, which is 13.4. Falling earnings per share is probably keeping traditional value investors away, but the relatively strong balance sheet will allow the company time to invest in growth. Clearly, the high P/E indicates shareholders think it will! Given Heritage-Crystal Clean's P/E ratio has declined from 73.1 to 49.2 in the last month, we know for sure that the market is significantly less confident about the business today, than it was back then. For those who don't like to trade against momentum, that could be a warning sign, but a contrarian investor might want to take a closer look.
Investors should be looking to buy stocks that the market is wrong about. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.
But note: Heritage-Crystal Clean 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.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.