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How Does Somero Enterprises's (LON:SOM) P/E Compare To Its Industry, After The Share Price Drop?

Simply Wall St

To the annoyance of some shareholders, Somero Enterprises (LON:SOM) shares are down a considerable 31% in the last month. Indeed the recent decline has arguably caused some bitterness for shareholders who have held through the 53% drop over 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). So, on certain occasions, long term focussed investors try to take advantage of pessimistic expectations to buy shares at a better price. One way to gauge market expectations of a stock 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.

See our latest analysis for Somero Enterprises

Does Somero Enterprises Have A Relatively High Or Low P/E For Its Industry?

Somero Enterprises's P/E of 7.21 indicates relatively low sentiment towards the stock. The image below shows that Somero Enterprises has a lower P/E than the average (17.7) P/E for companies in the machinery industry.

AIM:SOM Price Estimation Relative to Market, September 21st 2019

Somero Enterprises's P/E tells us that market participants think it will not fare as well as its peers in the same industry. Since the market seems unimpressed with Somero Enterprises, it's quite possible it could surprise on the upside. If you consider the stock interesting, further research is recommended. For example, 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. That means even if the current P/E is high, it will reduce over time if the share price stays flat. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.

Somero Enterprises's earnings per share fell by 2.1% in the last twelve months. But EPS is up 9.5% over the last 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.

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 Somero Enterprises's P/E?

Somero Enterprises has net cash of US$15m. This is fairly high at 11% of its market capitalization. That might mean balance sheet strength is important to the business, but should also help push the P/E a bit higher than it would otherwise be.

The Bottom Line On Somero Enterprises's P/E Ratio

Somero Enterprises's P/E is 7.2 which is below average (16.0) in the GB market. The recent drop in earnings per share would make investors cautious, but the net cash position means the company has time to improve: if so, the low P/E could be an opportunity. Given Somero Enterprises's P/E ratio has declined from 10.5 to 7.2 in the last month, we know for sure that the market is more worried about the business today, than it was back then. 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.

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 visual report on analyst forecasts could hold the key to an excellent investment decision.

But note: Somero Enterprises 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).

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.

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. Thank you for reading.