How Does Smiths Group's (LON:SMIN) P/E Compare To Its Industry, After The Share Price Drop?
To the annoyance of some shareholders, Smiths Group (LON:SMIN) shares are down a considerable 49% in the last month. Indeed the recent decline has arguably caused some bitterness for shareholders who have held through the 39% drop over twelve months.
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. 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.
View our latest analysis for Smiths Group
How Does Smiths Group's P/E Ratio Compare To Its Peers?
We can tell from its P/E ratio of 24.84 that there is some investor optimism about Smiths Group. The image below shows that Smiths Group has a higher P/E than the average (11.3) P/E for companies in the industrials industry.
That means that the market expects Smiths Group will outperform other companies in its industry. The market is optimistic about the future, but that doesn't guarantee future growth. 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
Companies that shrink earnings per share quickly will rapidly decrease the 'E' in the equation. Therefore, even if you pay a low multiple of earnings now, that multiple will become higher in the future. A higher P/E should indicate the stock is expensive relative to others -- and that may encourage shareholders to sell.
Smiths Group increased earnings per share by an impressive 20% over the last twelve months. In contrast, EPS has decreased by 9.8%, annually, over 5 years.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
Don't forget that the P/E ratio considers market capitalization. In other words, it does not consider any debt or cash that the company may have on the balance sheet. 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.
Such spending might be good or bad, overall, but the key point here is that you need to look at debt to understand the P/E ratio in context.
So What Does Smiths Group's Balance Sheet Tell Us?
Net debt is 35% of Smiths Group's market cap. You'd want to be aware of this fact, but it doesn't bother us.
The Bottom Line On Smiths Group's P/E Ratio
Smiths Group has a P/E of 24.8. That's higher than the average in its market, which is 11.2. While the company does use modest debt, its recent earnings growth is very good. Therefore, it's not particularly surprising that it has a above average P/E ratio. What can be absolutely certain is that the market has become significantly less optimistic about Smiths Group over the last month, with the P/E ratio falling from 49.0 back then to 24.8 today. For those who prefer to invest with the flow of momentum, that might be a bad sign, but for a contrarian, it may signal opportunity.
Investors should be looking to buy stocks that the market is wrong about. 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 visual report on analyst forecasts could hold the key to an excellent investment decision.
Of course you might be able to find a better stock than Smiths Group. So you may wish to see this free collection of other companies that have grown earnings strongly.
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.
