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Here's How P/E Ratios Can Help Us Understand Ocean Bio-Chem, Inc. (NASDAQ:OBCI)

Simply Wall St

Unfortunately for some shareholders, the Ocean Bio-Chem (NASDAQ:OBCI) share price has dived in the last thirty days. Even longer term holders have taken a real hit with the stock declining 7.9% in the last year.

Assuming no other changes, a sharply higher share price makes a stock less attractive to potential buyers. 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). Investors have optimistic expectations of companies with higher P/E ratios, compared to companies with lower P/E ratios.

View our latest analysis for Ocean Bio-Chem

How Does Ocean Bio-Chem's P/E Ratio Compare To Its Peers?

We can tell from its P/E ratio of 11.61 that sentiment around Ocean Bio-Chem isn't particularly high. The image below shows that Ocean Bio-Chem has a lower P/E than the average (26.8) P/E for companies in the household products industry.

NasdaqCM:OBCI Price Estimation Relative to Market, January 19th 2020

Its relatively low P/E ratio indicates that Ocean Bio-Chem shareholders think it will struggle to do as well as other companies in its industry classification. Many investors like to buy stocks when the market is pessimistic about their prospects. You 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. Earnings growth means that in the future the 'E' will be higher. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.

Ocean Bio-Chem shrunk earnings per share by 16% over the last year. But over the longer term (5 years) earnings per share have increased by 6.6%.

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

The 'Price' in P/E reflects the market capitalization of the company. In other words, it does not consider any debt or cash that the company may have on the balance sheet. 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).

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.

How Does Ocean Bio-Chem's Debt Impact Its P/E Ratio?

Net debt totals just 7.8% of Ocean Bio-Chem'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 Bottom Line On Ocean Bio-Chem's P/E Ratio

Ocean Bio-Chem's P/E is 11.6 which is below average (19.0) in the US market. The debt levels are not a major concern, but the lack of EPS growth is likely weighing on sentiment. Given Ocean Bio-Chem's P/E ratio has declined from 11.6 to 11.6 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 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 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. Although we don't have analyst forecasts you might want to assess this data-rich visualization of earnings, revenue and cash flow.

You might be able to find a better buy than Ocean Bio-Chem. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).

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.