To the annoyance of some shareholders, Provident Financial Services (NYSE:PFS) shares are down a considerable 39% in the last month. Indeed the recent decline has arguably caused some bitterness for shareholders who have held through the 49% drop over twelve months.
Assuming nothing else has changed, a lower share price makes a stock more attractive to potential buyers. 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). 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 Provident Financial Services Have A Relatively High Or Low P/E For Its Industry?
We can tell from its P/E ratio of 7.51 that sentiment around Provident Financial Services isn't particularly high. We can see in the image below that the average P/E (10.7) for companies in the mortgage industry is higher than Provident Financial Services's P/E.
This suggests that market participants think Provident Financial Services will underperform other companies in its industry. Many investors like to buy stocks when the market is pessimistic about their prospects. You should delve deeper. I like to check if company insiders have been buying or selling.
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. 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.
Provident Financial Services's earnings per share fell by 4.4% in the last twelve months. But over the longer term (5 years) earnings per share have increased by 7.4%.
Remember: P/E Ratios Don't Consider The Balance Sheet
Don't forget that the P/E ratio considers market capitalization. That means it doesn't take debt or cash into account. 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).
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.
Is Debt Impacting Provident Financial Services's P/E?
Net debt totals a substantial 113% of Provident Financial Services's market cap. This level of debt justifies a relatively low P/E, so remain cognizant of the debt, if you're comparing it to other stocks.
The Bottom Line On Provident Financial Services's P/E Ratio
Provident Financial Services trades on a P/E ratio of 7.5, which is below the US market average of 13.4. The P/E reflects market pessimism that probably arises from the lack of recent EPS growth, paired with significant leverage. What can be absolutely certain is that the market has become more pessimistic about Provident Financial Services over the last month, with the P/E ratio falling from 12.4 back then to 7.5 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 should be looking to buy stocks that the market is wrong about. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. 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.
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 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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