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Unfortunately for some shareholders, the FLIR Systems (NASDAQ:FLIR) share price has dived 32% in the last thirty days. Even longer term holders have taken a real hit with the stock declining 29% in the last year.
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. 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.
Does FLIR Systems Have A Relatively High Or Low P/E For Its Industry?
FLIR Systems's P/E of 28.39 indicates some degree of optimism towards the stock. You can see in the image below that the average P/E (15.7) for companies in the electronic industry is lower than FLIR Systems's P/E.
FLIR Systems's P/E tells us that market participants think the company will perform better than its industry peers, going forward. Shareholders are clearly optimistic, but the future is always uncertain. So further research is always essential. 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. 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. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
FLIR Systems's earnings per share fell by 38% in the last twelve months. But it has grown its earnings per share by 1.5% per year over the last three years. And it has shrunk its earnings per share by 2.2% per year over the last five years. This could justify a pessimistic P/E.
Remember: P/E Ratios Don't Consider The Balance Sheet
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. 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 expenditure might be good or bad, in the long term, but the point here is that the balance sheet is not reflected by this ratio.
FLIR Systems's Balance Sheet
Net debt totals just 8.1% of FLIR Systems's market cap. The market might award it a higher P/E ratio if it had net cash, but its unlikely this low level of net borrowing is having a big impact on the P/E multiple.
The Verdict On FLIR Systems's P/E Ratio
FLIR Systems's P/E is 28.4 which is above average (15.1) in its market. With some debt but no EPS growth last year, the market has high expectations of future profits. What can be absolutely certain is that the market has become significantly less optimistic about FLIR Systems over the last month, with the P/E ratio falling from 41.7 back then to 28.4 today. 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 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.
But note: FLIR Systems 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).
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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