To the annoyance of some shareholders, LyondellBasell Industries (NYSE:LYB) shares are down a considerable 36% in the last month. Indeed the recent decline has arguably caused some bitterness for shareholders who have held through the 38% 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. One way to gauge market expectations of a stock 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.
How Does LyondellBasell Industries's P/E Ratio Compare To Its Peers?
We can tell from its P/E ratio of 5.62 that sentiment around LyondellBasell Industries isn't particularly high. We can see in the image below that the average P/E (17.3) for companies in the chemicals industry is higher than LyondellBasell Industries's P/E.
This suggests that market participants think LyondellBasell Industries will underperform other companies in its industry. 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
P/E ratios primarily reflect market expectations around earnings growth rates. When earnings grow, the 'E' increases, over time. That means unless the share price increases, the P/E will reduce in a few years. Then, a lower P/E should attract more buyers, pushing the share price up.
LyondellBasell Industries shrunk earnings per share by 20% over the last year. But it has grown its earnings per share by 3.6% per year over the last five years.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
Don't forget that the P/E ratio considers market capitalization. That means it doesn't take debt or cash into account. 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 expenditure might be good or bad, in the long term, but the point here is that the balance sheet is not reflected by this ratio.
How Does LyondellBasell Industries's Debt Impact Its P/E Ratio?
Net debt totals 61% of LyondellBasell Industries'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 LyondellBasell Industries's P/E Ratio
LyondellBasell Industries's P/E is 5.6 which is below average (14.7) in the US market. The P/E reflects market pessimism that probably arises from the lack of recent EPS growth, paired with significant leverage. Given LyondellBasell Industries's P/E ratio has declined from 8.7 to 5.6 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 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 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.
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