Unfortunately for some shareholders, the NACCO Industries (NYSE:NC) share price has dived 33% in the last thirty days. The recent drop has obliterated the annual return, with the share price now down 16% over that longer period.
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). Investors have optimistic expectations of companies with higher P/E ratios, compared to companies with lower P/E ratios.
Does NACCO Industries Have A Relatively High Or Low P/E For Its Industry?
We can tell from its P/E ratio of 5.67 that sentiment around NACCO Industries isn't particularly high. We can see in the image below that the average P/E (7.5) for companies in the oil and gas industry is higher than NACCO Industries's P/E.
This suggests that market participants think NACCO Industries will underperform other companies in its industry. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. 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. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. And as that P/E ratio drops, the company will look cheap, unless its share price increases.
It's great to see that NACCO Industries grew EPS by 13% in the last year. And it has improved its earnings per share by 136% per year over the last three years. So one might expect an above average P/E ratio.
Remember: P/E Ratios Don't Consider The Balance Sheet
Don't forget that the P/E ratio considers market capitalization. In other words, it does not consider any debt or cash that the company may have on the balance sheet. 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).
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.
How Does NACCO Industries's Debt Impact Its P/E Ratio?
With net cash of US$99m, NACCO Industries has a very strong balance sheet, which may be important for its business. Having said that, at 44% of its market capitalization the cash hoard would contribute towards a higher P/E ratio.
The Bottom Line On NACCO Industries's P/E Ratio
NACCO Industries trades on a P/E ratio of 5.7, which is below the US market average of 15.1. Not only should the net cash position reduce risk, but the recent growth has been impressive. The relatively low P/E ratio implies the market is pessimistic. What can be absolutely certain is that the market has become more pessimistic about NACCO Industries over the last month, with the P/E ratio falling from 8.4 back then to 5.7 today. For those who prefer invest in growth, this stock apparently offers limited promise, but the deep value investors may find the pessimism around this stock enticing.
Investors have an opportunity when market expectations about a stock are wrong. As value investor Benjamin Graham famously said, 'In the short run, the market is a voting machine but in the long run, it is a weighing machine. Although we don't have analyst forecasts you could get a better understanding of its growth by checking out this more detailed historical graph of earnings, revenue and cash flow.
But note: NACCO Industries 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 firstname.lastname@example.org. 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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