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Unfortunately for some shareholders, the Universal Forest Products (NASDAQ:UFPI) share price has dived 32% in the last thirty days. Looking back further, the stock is up 9.1% in the last year.
Assuming nothing else has changed, a lower share price makes a stock more attractive to potential buyers. 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. 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). Investors have optimistic expectations of companies with higher P/E ratios, compared to companies with lower P/E ratios.
Does Universal Forest Products Have A Relatively High Or Low P/E For Its Industry?
We can tell from its P/E ratio of 11.63 that sentiment around Universal Forest Products isn't particularly high. If you look at the image below, you can see Universal Forest Products has a lower P/E than the average (19.3) in the building industry classification.
Its relatively low P/E ratio indicates that Universal Forest Products shareholders think it will struggle to do as well as other companies in its industry classification. Since the market seems unimpressed with Universal Forest Products, 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
Earnings growth rates have a big influence on P/E ratios. When earnings grow, the 'E' increases, over time. 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.
It's great to see that Universal Forest Products grew EPS by 21% in the last year. And it has bolstered its earnings per share by 25% per year over the last five years. With that performance, you might expect an above average P/E ratio.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. In other words, it does not consider any debt or cash that the company may have on the balance sheet. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
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 Universal Forest Products's P/E?
The extra options and safety that comes with Universal Forest Products's US$23m net cash position means that it deserves a higher P/E than it would if it had a lot of net debt.
The Bottom Line On Universal Forest Products's P/E Ratio
Universal Forest Products's P/E is 11.6 which is below average (12.7) in the US market. The net cash position gives plenty of options to the business, and the recent improvement in EPS is good to see. The relatively low P/E ratio implies the market is pessimistic. Given analysts are expecting further growth, one I would have expected a higher P/E ratio. So this stock may well be worth further research. Given Universal Forest Products's P/E ratio has declined from 17.1 to 11.6 in the last month, we know for sure that the market is significantly less confident about the business today, than it was back then. 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 it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. So this free report on the analyst consensus forecasts could help you make a master move on this stock.
Of course you might be able to find a better stock than Universal Forest Products. 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 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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