To the annoyance of some shareholders, Lectra (EPA:LSS) shares are down a considerable 34% in the last month. That drop has capped off a tough year for shareholders, with the share price down 35% in that time.
All else being equal, a share price drop should make a stock more attractive to potential investors. 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 implies that investors have high expectations of what a company can achieve compared to a company with a low P/E ratio.
How Does Lectra's P/E Ratio Compare To Its Peers?
Lectra's P/E of 15.23 indicates relatively low sentiment towards the stock. The image below shows that Lectra has a lower P/E than the average (27.1) P/E for companies in the software industry.
Its relatively low P/E ratio indicates that Lectra shareholders think it will struggle to do as well as other companies in its industry classification. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. You should delve deeper. I like to check if company insiders have been buying or selling.
How Growth Rates Impact P/E Ratios
Earnings growth rates have a big influence on P/E ratios. When earnings grow, the 'E' increases, over time. 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.
Lectra's earnings per share were pretty steady over the last year. But EPS is up 14% over the last 5 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. Thus, the metric does not reflect cash or debt held by the company. The exact same company would hypothetically deserve a higher P/E ratio if it had a strong balance sheet, than if it had a weak one with lots of debt, because a cashed up company can spend on 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.
Lectra's Balance Sheet
With net cash of €121m, Lectra has a very strong balance sheet, which may be important for its business. Having said that, at 27% of its market capitalization the cash hoard would contribute towards a higher P/E ratio.
The Verdict On Lectra's P/E Ratio
Lectra has a P/E of 15.2. That's higher than the average in its market, which is 13.2. Earnings improved over the last year. And the healthy balance sheet means the company can sustain growth while the P/E suggests shareholders think it will. Given Lectra's P/E ratio has declined from 23.2 to 15.2 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.
When the market is wrong about a stock, it gives savvy investors an opportunity. 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 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 Lectra. So you may wish to see this free collection of other companies that have grown earnings strongly.
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