Unfortunately for some shareholders, the Profire Energy (NASDAQ:PFIE) share price has dived 30% in the last thirty days. That drop has capped off a tough year for shareholders, with the share price down 47% in that time.
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. One way to gauge market expectations of a stock 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 Profire Energy Have A Relatively High Or Low P/E For Its Industry?
Profire Energy's P/E is 10.21. As you can see below Profire Energy has a P/E ratio that is fairly close for the average for the energy services industry, which is 9.8.
That indicates that the market expects Profire Energy will perform roughly in line with other companies in its industry. So if Profire Energy actually outperforms its peers going forward, that should be a positive for the share price. Further research into factors such as insider buying and selling, could help you form your own view on whether that is likely.
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. Earnings growth means that in the future the 'E' will be higher. That means unless the share price increases, the P/E will reduce in a few years. Then, a lower P/E should attract more buyers, pushing the share price up.
Profire Energy shrunk earnings per share by 32% over the last year. And EPS is down 6.4% a year, over the last 5 years. This might lead to muted expectations.
Remember: P/E Ratios Don't Consider The Balance Sheet
Don't forget that the P/E ratio considers market capitalization. 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.
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.
So What Does Profire Energy's Balance Sheet Tell Us?
With net cash of US$13m, Profire Energy has a very strong balance sheet, which may be important for its business. Having said that, at 29% of its market capitalization the cash hoard would contribute towards a higher P/E ratio.
The Verdict On Profire Energy's P/E Ratio
Profire Energy's P/E is 10.2 which is below average (14.7) in the US market. Falling earnings per share are likely to be keeping potential buyers away, but the net cash position means the company has time to improve: if so, the low P/E could be an opportunity. Given Profire Energy's P/E ratio has declined from 14.7 to 10.2 in the last month, we know for sure that the market is less confident about the business today, than it was back then. 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.
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 visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.
You might be able to find a better buy than Profire Energy. 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.
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