To the annoyance of some shareholders, ITV (LON:ITV) shares are down a considerable 54% in the last month. Indeed the recent decline has arguably caused some bitterness for shareholders who have held through the 53% drop over twelve months.
Assuming nothing else has changed, a lower share price makes a stock more 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, 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 ratio means that investors have a high expectation about future growth, while a low P/E ratio means they have low expectations about future growth.
Does ITV Have A Relatively High Or Low P/E For Its Industry?
We can tell from its P/E ratio of 5.08 that sentiment around ITV isn't particularly high. We can see in the image below that the average P/E (15.3) for companies in the media industry is higher than ITV's P/E.
ITV'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 ITV, 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
Probably the most important factor in determining what P/E a company trades on is the earnings growth. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.
ITV maintained roughly steady earnings over the last twelve months. But over the longer term (3 years), earnings per share have increased by 1.8%.
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. So it won't reflect the advantage of cash, or disadvantage of debt. Theoretically, a business can improve its earnings (and produce a lower P/E in the future) by investing in growth. That means taking on debt (or spending its cash).
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.
ITV's Balance Sheet
ITV's net debt equates to 34% of its market capitalization. While that's enough to warrant consideration, it doesn't really concern us.
The Bottom Line On ITV's P/E Ratio
ITV trades on a P/E ratio of 5.1, which is below the GB market average of 11.1. The company hasn't stretched its balance sheet, and earnings are improving. The P/E ratio implies the market is cautious about longer term prospects. What can be absolutely certain is that the market has become more pessimistic about ITV over the last month, with the P/E ratio falling from 11.0 back then to 5.1 today. 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 have an opportunity when market expectations about a stock are wrong. 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 be able to find a better stock than ITV. So you may wish to see this free collection of other companies that have grown earnings strongly.
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.
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.