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Here's What Continental Seeds and Chemicals Limited's (NSE:CONTI) P/E Ratio Is Telling Us

Simply Wall St

Unfortunately for some shareholders, the Continental Seeds and Chemicals (NSE:CONTI) share price has dived in the last thirty days. The bad news is that the recent drop obliterated the last year's worth of gains; the stock is flat over twelve months.

All else being equal, a sharp share price increase should make a stock less 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). The implication here is that deep value investors might steer clear when expectations of a company are too high. 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.

See our latest analysis for Continental Seeds and Chemicals

Does Continental Seeds and Chemicals Have A Relatively High Or Low P/E For Its Industry?

We can tell from its P/E ratio of 16.78 that there is some investor optimism about Continental Seeds and Chemicals. The image below shows that Continental Seeds and Chemicals has a higher P/E than the average (14.1) P/E for companies in the food industry.

NSEI:CONTI Price Estimation Relative to Market, October 13th 2019

Continental Seeds and Chemicals'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 investors should delve deeper. I like to check if company insiders have been buying or 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. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. And as that P/E ratio drops, the company will look cheap, unless its share price increases.

Continental Seeds and Chemicals's earnings per share fell by 36% in the last twelve months. But EPS is up 9.4% over the last 5 years.

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.

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 Continental Seeds and Chemicals's Balance Sheet Tell Us?

Net debt is 47% of Continental Seeds and Chemicals's market cap. While it's worth keeping this in mind, it isn't a worry.

The Verdict On Continental Seeds and Chemicals's P/E Ratio

Continental Seeds and Chemicals's P/E is 16.8 which is above average (13.1) in its market. With some debt but no EPS growth last year, the market has high expectations of future profits. Given Continental Seeds and Chemicals's P/E ratio has declined from 16.8 to 16.8 in the last month, we know for sure that the market is 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 have an opportunity when market expectations about a stock are wrong. People often underestimate remarkable growth -- so investors can make money when fast growth is not fully appreciated. Although we don't have analyst forecasts shareholders might want to examine this detailed historical graph of earnings, revenue and cash flow.

But note: Continental Seeds and Chemicals 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.