To the annoyance of some shareholders, NetSol Technologies (NASDAQ:NTWK) shares are down a considerable 38% in the last month. And that drop will have no doubt have some shareholders concerned that the 68% 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.
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. 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 NetSol Technologies's P/E Ratio Compare To Its Peers?
NetSol Technologies's P/E of 8.02 indicates relatively low sentiment towards the stock. If you look at the image below, you can see NetSol Technologies has a lower P/E than the average (37.1) in the software industry classification.
Its relatively low P/E ratio indicates that NetSol Technologies 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
Earnings growth rates have a big influence on P/E ratios. When earnings grow, the 'E' increases, over time. 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.
NetSol Technologies's earnings per share fell by 56% in the last twelve months. But EPS is up 103% over the last 3 years.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
The 'Price' in P/E reflects the market capitalization of the company. That means it doesn't take debt or cash into account. In theory, a company can lower its future P/E ratio by using cash or debt to invest in 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 NetSol Technologies's Debt Impact Its P/E Ratio?
With net cash of US$13m, NetSol Technologies has a very strong balance sheet, which may be important for its business. Having said that, at 45% of its market capitalization the cash hoard would contribute towards a higher P/E ratio.
The Verdict On NetSol Technologies's P/E Ratio
NetSol Technologies has a P/E of 8.0. That's below the average in the US market, which is 13.3. Falling earnings per share are likely to be keeping potential buyers away, 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 more pessimistic about NetSol Technologies over the last month, with the P/E ratio falling from 12.9 back then to 8.0 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.
When the market is wrong about a stock, it gives savvy investors an opportunity. 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. So this free report on the analyst consensus forecasts could help you make a master move on this stock.
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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