To the annoyance of some shareholders, Image Resources (ASX:IMA) shares are down a considerable 32% in the last month. Indeed the recent decline has arguably caused some bitterness for shareholders who have held through the 32% drop over twelve months.
All else being equal, a share price drop should make a stock more 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 long term investors have an opportunity when expectations of a company are too low. 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 implies that investors have high expectations of what a company can achieve compared to a company with a low P/E ratio.
How Does Image Resources's P/E Ratio Compare To Its Peers?
We can tell from its P/E ratio of 6.06 that sentiment around Image Resources isn't particularly high. We can see in the image below that the average P/E (8.0) for companies in the metals and mining industry is higher than Image Resources's P/E.
Its relatively low P/E ratio indicates that Image Resources shareholders think it will struggle to do as well as other companies in its industry classification. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. 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
Probably the most important factor in determining what P/E a company trades on is the earnings growth. When earnings grow, the 'E' increases, over time. And in that case, the P/E ratio itself will drop rather quickly. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.
In the last year, Image Resources grew EPS like Taylor Swift grew her fan base back in 2010; the 456% gain was both fast and well deserved.
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. 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 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.
Is Debt Impacting Image Resources's P/E?
Image Resources has net debt worth just 5.1% of its market capitalization. So it doesn't have as many options as it would with net cash, but its debt would not have much of an impact on its P/E ratio.
The Verdict On Image Resources's P/E Ratio
Image Resources trades on a P/E ratio of 6.1, which is below the AU market average of 13.0. The company does have a little debt, and EPS growth was good last year. The low P/E ratio suggests current market expectations are muted, implying these levels of growth will not continue. Given analysts are expecting further growth, one might have expected a higher P/E ratio. That may be worth further research. What can be absolutely certain is that the market has become more pessimistic about Image Resources over the last month, with the P/E ratio falling from 8.9 back then to 6.1 today. For those who prefer to invest with the flow of momentum, that might be a bad sign, but for deep value investors this stock might justify some research.
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 Image Resources. 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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