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How Does Korn Ferry's (NYSE:KFY) P/E Compare To Its Industry, After The Share Price Drop?

Simply Wall St

To the annoyance of some shareholders, Korn Ferry (NYSE:KFY) shares are down a considerable 35% in the last month. Indeed the recent decline has arguably caused some bitterness for shareholders who have held through the 51% 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. The implication here is that long term investors have an opportunity when expectations of a company are too low. 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.

See our latest analysis for Korn Ferry

Does Korn Ferry Have A Relatively High Or Low P/E For Its Industry?

Korn Ferry's P/E of 8.28 indicates relatively low sentiment towards the stock. We can see in the image below that the average P/E (11.8) for companies in the professional services industry is higher than Korn Ferry's P/E.

NYSE:KFY Price Estimation Relative to Market April 4th 2020
NYSE:KFY Price Estimation Relative to Market April 4th 2020

Its relatively low P/E ratio indicates that Korn Ferry 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. You should delve deeper. I like to check if company insiders have been buying or selling.

How Growth Rates Impact P/E Ratios

Generally speaking the rate of earnings growth has a profound impact on a company's P/E multiple. Earnings growth means that in the future the 'E' will be higher. And in that case, the P/E ratio itself will drop rather quickly. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.

In the last year, Korn Ferry grew EPS like Taylor Swift grew her fan base back in 2010; the 69% gain was both fast and well deserved. Even better, EPS is up 36% per year over three years. So you might say it really deserves to have an above-average P/E ratio.

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).

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).

So What Does Korn Ferry's Balance Sheet Tell Us?

With net cash of US$170m, Korn Ferry has a very strong balance sheet, which may be important for its business. Having said that, at 13% of its market capitalization the cash hoard would contribute towards a higher P/E ratio.

The Verdict On Korn Ferry's P/E Ratio

Korn Ferry's P/E is 8.3 which is below average (12.4) in the US market. It grew its EPS nicely over the last year, and the healthy balance sheet implies there is more potential for growth. The below average P/E ratio suggests that market participants don't believe the strong growth will continue. What can be absolutely certain is that the market has become more pessimistic about Korn Ferry over the last month, with the P/E ratio falling from 12.7 back then to 8.3 today. For those who prefer invest in growth, this stock apparently offers limited promise, but the deep value investors may find the pessimism around this stock enticing.

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 visual report on analyst forecasts could hold the key to an excellent investment decision.

Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.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.