Those holding NRW Holdings (ASX:NWH) shares must be pleased that the share price has rebounded 32% in the last thirty days. But unfortunately, the stock is still down by 31% over a quarter. But shareholders may not all be feeling jubilant, since the share price is still down 27% in the last year.
All else being equal, a sharp share price increase should make a stock less 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). So some would prefer to hold off buying when there is a lot of optimism towards a stock. 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.
Does NRW Holdings Have A Relatively High Or Low P/E For Its Industry?
NRW Holdings's P/E of 22.10 indicates some degree of optimism towards the stock. As you can see below, NRW Holdings has a higher P/E than the average company (16.4) in the construction industry.
Its relatively high P/E ratio indicates that NRW Holdings shareholders think it will perform better than other companies in its industry classification. Clearly the market expects growth, but it isn't guaranteed. So further research is always essential. I often monitor director buying and selling.
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. When earnings grow, the 'E' increases, over time. And in that case, the P/E ratio itself will drop rather quickly. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
NRW Holdings saw earnings per share decrease by 33% last year. But over the longer term (3 years), earnings per share have increased by 2.5%.
Remember: P/E Ratios Don't Consider The Balance Sheet
The 'Price' in P/E reflects the market capitalization of the company. Thus, the metric does not reflect cash or debt held by the company. 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.
NRW Holdings's Balance Sheet
NRW Holdings has net cash of AU$58m. That should lead to a higher P/E than if it did have debt, because its strong balance sheets gives it more options.
The Bottom Line On NRW Holdings's P/E Ratio
NRW Holdings trades on a P/E ratio of 22.1, 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 we know for sure is that investors have become much more excited about NRW Holdings recently, since they have pushed its P/E ratio from 16.7 to 22.1 over the last month. For those who prefer to invest with the flow of momentum, that might mean it's time to put the stock on a watchlist, or research it. But the contrarian may see it as a missed opportunity.
Investors have an opportunity when market expectations about a stock are wrong. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. 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 NRW Holdings. 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).
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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. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned. Thank you for reading.