To the annoyance of some shareholders, M.D.C. Holdings (NYSE:MDC) shares are down a considerable 36% in the last month. Even longer term holders have taken a real hit with the stock declining 8.4% in the last year.
All else being equal, a share price drop should make a stock more attractive to potential investors. 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). 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.
Does M.D.C. Holdings Have A Relatively High Or Low P/E For Its Industry?
We can tell from its P/E ratio of 6.93 that sentiment around M.D.C. Holdings isn't particularly high. We can see in the image below that the average P/E (8.1) for companies in the consumer durables industry is higher than M.D.C. Holdings's P/E.
Its relatively low P/E ratio indicates that M.D.C. Holdings 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
Probably the most important factor in determining what P/E a company trades on is the earnings growth. 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. And as that P/E ratio drops, the company will look cheap, unless its share price increases.
Most would be impressed by M.D.C. Holdings earnings growth of 11% in the last year. And it has bolstered its earnings per share by 29% per year over the last five years. So one might expect an above average P/E ratio.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
Don't forget that the P/E ratio considers market capitalization. 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.
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.
So What Does M.D.C. Holdings's Balance Sheet Tell Us?
M.D.C. Holdings has net debt equal to 43% of its market cap. While that's enough to warrant consideration, it doesn't really concern us.
The Verdict On M.D.C. Holdings's P/E Ratio
M.D.C. Holdings's P/E is 6.9 which is below average (13.4) in the US market. The company does have a little debt, and EPS growth was good last year. If the company can continue to grow earnings, then the current P/E may be unjustifiably low. Because analysts are predicting more growth in the future, one might have expected to see a higher P/E ratio. You can take a closer look at the fundamentals, here. What can be absolutely certain is that the market has become more pessimistic about M.D.C. Holdings over the last month, with the P/E ratio falling from 10.8 back then to 6.9 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.
When the market is wrong about a stock, it gives savvy investors an opportunity. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. So this free report on the analyst consensus forecasts could help you make a master move on this stock.
But note: M.D.C. Holdings 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 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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