To the annoyance of some shareholders, Moelis (NYSE:MC) shares are down a considerable 30% in the last month. That drop has capped off a tough year for shareholders, with the share price down 38% in that time.
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. So, on certain occasions, long term focussed investors try to take advantage of pessimistic expectations to buy shares at a better price. One way to gauge market expectations of a stock 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 Moelis's P/E Ratio Compare To Its Peers?
Moelis's P/E of 12.96 indicates relatively low sentiment towards the stock. We can see in the image below that the average P/E (28.0) for companies in the capital markets industry is higher than Moelis's P/E.
Moelis'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 Moelis, it's quite possible it could surprise on the upside. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.
How Growth Rates Impact P/E Ratios
P/E ratios primarily reflect market expectations around earnings growth rates. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. That means unless the share price increases, the P/E will reduce in a few years. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
Moelis shrunk earnings per share by 32% over the last year. But it has grown its earnings per share by 4.0% per year over the last three years.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. In other words, it does not consider any debt or cash that the company may have on the balance sheet. 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.
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).
How Does Moelis's Debt Impact Its P/E Ratio?
The extra options and safety that comes with Moelis's US$168m net cash position means that it deserves a higher P/E than it would if it had a lot of net debt.
The Verdict On Moelis's P/E Ratio
Moelis has a P/E of 13.0. That's below the average in the US market, which is 15.1. The recent drop in earnings per share would make investors cautious, the relatively strong balance sheet will allow the company time to invest in growth. If it achieves that, then there's real potential that the low P/E could eventually indicate undervaluation. What can be absolutely certain is that the market has become significantly less optimistic about Moelis over the last month, with the P/E ratio falling from 18.6 back then to 13.0 today. For those who prefer to invest with the flow of momentum, that might be a bad sign, but for a contrarian, it may signal opportunity.
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.
You might be able to find a better buy than Moelis. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
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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