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How Does Northern Star Resources's (ASX:NST) P/E Compare To Its Industry, After The Share Price Drop?

Simply Wall St

Unfortunately for some shareholders, the Northern Star Resources (ASX:NST) share price has dived 32% in the last thirty days. Indeed, the recent drop has reduced the annual gain to a relatively sedate 5.1% over the last twelve months.

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. 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 implies that investors have high expectations of what a company can achieve compared to a company with a low P/E ratio.

Check out our latest analysis for Northern Star Resources

How Does Northern Star Resources's P/E Ratio Compare To Its Peers?

Northern Star Resources's P/E of 29.60 indicates some degree of optimism towards the stock. As you can see below, Northern Star Resources has a much higher P/E than the average company (8.2) in the metals and mining industry.

ASX:NST Price Estimation Relative to Market, March 16th 2020
ASX:NST Price Estimation Relative to Market, March 16th 2020

Its relatively high P/E ratio indicates that Northern Star Resources shareholders think it will perform better than other companies in its industry classification. Clearly the market expects growth, but it isn't guaranteed. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.

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. That's because companies that grow earnings per share quickly will rapidly increase the 'E' in the equation. That means unless the share price increases, the P/E will reduce in a few years. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.

Northern Star Resources saw earnings per share decrease by 2.6% last year. But it has grown its earnings per share by 28% per year over the last five years.

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. So it won't reflect the advantage of cash, or disadvantage of debt. 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).

Is Debt Impacting Northern Star Resources's P/E?

With net cash of AU$870m, Northern Star Resources has a very strong balance sheet, which may be important for its business. Having said that, at 11% of its market capitalization the cash hoard would contribute towards a higher P/E ratio.

The Verdict On Northern Star Resources's P/E Ratio

Northern Star Resources trades on a P/E ratio of 29.6, which is above its market average of 14.9. The recent drop in earnings per share might keep value investors away, but the healthy balance sheet means the company retains the potential for future growth. If this growth fails to materialise, the current high P/E could prove to be temporary, as the share price falls. What can be absolutely certain is that the market has become significantly less optimistic about Northern Star Resources over the last month, with the P/E ratio falling from 43.7 back then to 29.6 today. For those who don't like to trade against momentum, that could be a warning sign, but a contrarian investor might want to take a closer look.

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.

But note: Northern Star Resources 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 editorial-team@simplywallst.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.