Unfortunately for some shareholders, the MTS Systems (NASDAQ:MTSC) share price has dived 67% in the last thirty days. And that drop will have no doubt have some shareholders concerned that the 72% share price decline, over the last year, has turned them into bagholders. For those wondering, a bagholder is someone who keeps holding a losing stock indefinitely, without taking the time to consider its prospects carefully, going forward.
Assuming nothing else has changed, a lower share price makes a stock more attractive to potential buyers. 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). So, on certain occasions, long term focussed investors try to take advantage of pessimistic expectations to buy shares at a better price. 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.
How Does MTS Systems's P/E Ratio Compare To Its Peers?
MTS Systems's P/E of 7.75 indicates relatively low sentiment towards the stock. The image below shows that MTS Systems has a lower P/E than the average (13.0) P/E for companies in the electronic industry.
Its relatively low P/E ratio indicates that MTS Systems 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. 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
Generally speaking the rate of earnings growth has a profound impact on a company's P/E multiple. When earnings grow, the 'E' increases, over time. That means even if the current P/E is high, it will reduce over time if the share price stays flat. Then, a lower P/E should attract more buyers, pushing the share price up.
MTS Systems shrunk earnings per share by 3.0% last year. But it has grown its earnings per share by 24% per year over the last three years. And it has shrunk its earnings per share by 8.6% per year over the last five years. So we might expect a relatively low P/E.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. That means it doesn't take debt or cash into account. 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).
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.
MTS Systems's Balance Sheet
MTS Systems has net debt worth a very significant 165% of its market capitalization. This level of debt justifies a relatively low P/E, so remain cognizant of the debt, if you're comparing it to other stocks.
The Verdict On MTS Systems's P/E Ratio
MTS Systems trades on a P/E ratio of 7.7, which is below the US market average of 11.5. When you consider that the company has significant debt, and didn't grow EPS last year, it isn't surprising that the market has muted expectations. Given MTS Systems's P/E ratio has declined from 23.2 to 7.7 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 have an opportunity when market expectations about a stock are wrong. If the reality for a company is not as bad as the P/E ratio indicates, then the share price should increase as the market realizes this. 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 MTS Systems. 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.
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.