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Here's How P/E Ratios Can Help Us Understand Chicago Rivet & Machine Co. (NYSEMKT:CVR)

To the annoyance of some shareholders, Chicago Rivet & Machine (NYSEMKT:CVR) shares are down a considerable in the last month. Even longer term holders have taken a real hit with the stock declining 5.6% in the last year. On the bright side, the share price is slightly up over the last 90 days.

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. One way to gauge market expectations of a stock 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 Chicago Rivet & Machine

How Does Chicago Rivet & Machine's P/E Ratio Compare To Its Peers?

Chicago Rivet & Machine has a P/E ratio of 22.39. The image below shows that Chicago Rivet & Machine has a P/E ratio that is roughly in line with the machinery industry average (22.5).

AMEX:CVR Price Estimation Relative to Market, January 26th 2020
AMEX:CVR Price Estimation Relative to Market, January 26th 2020

That indicates that the market expects Chicago Rivet & Machine will perform roughly in line with other companies in its industry. The company could surprise by performing better than average, in the future. Further research into factors such as insider buying and selling, could help you form your own view on whether that is likely.

How Growth Rates Impact P/E Ratios

When earnings fall, the 'E' decreases, over time. That means even if the current P/E is low, it will increase over time if the share price stays flat. Then, a higher P/E might scare off shareholders, pushing the share price down.

Chicago Rivet & Machine's earnings per share fell by 54% in the last twelve months. And it has shrunk its earnings per share by 13% per year over the last five years. This could justify a pessimistic P/E.

Remember: P/E Ratios Don't Consider The Balance Sheet

The 'Price' in P/E reflects the market capitalization of the company. Thus, the metric does not reflect cash or debt held by the company. Theoretically, a business can improve its earnings (and produce a lower P/E in the future) by investing in growth. That means taking on debt (or spending its cash).

Spending on growth might be good or bad a few years later, but the point is that the P/E ratio does not account for the option (or lack thereof).

So What Does Chicago Rivet & Machine's Balance Sheet Tell Us?

Chicago Rivet & Machine has net cash of US$7.3m. This is fairly high at 28% 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 Chicago Rivet & Machine's P/E Ratio

Chicago Rivet & Machine's P/E is 22.4 which is above average (18.6) in its market. Falling earnings per share is probably keeping traditional value investors away, but the relatively strong balance sheet will allow the company time to invest in growth. Clearly, the high P/E indicates shareholders think it will! Given Chicago Rivet & Machine's P/E ratio has declined from 22.4 to 22.4 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 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. Although we don't have analyst forecasts you might want to assess this data-rich visualization of earnings, revenue and cash flow.

But note: Chicago Rivet & Machine 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 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.