IVE Group (ASX:IGL) shareholders are no doubt pleased to see that the share price has bounced 31% in the last month alone, although it is still down 74% over the last quarter. However, that doesn't change the fact that longer term shareholders might have been mercilessly wrecked by the 73% share price decline throughout the 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). So some would prefer to hold off buying when there is a lot of optimism towards a stock. 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.
Does IVE Group Have A Relatively High Or Low P/E For Its Industry?
IVE Group's P/E of 3.49 indicates relatively low sentiment towards the stock. If you look at the image below, you can see IVE Group has a lower P/E than the average (15.8) in the media industry classification.
IVE Group's P/E tells us that market participants think it will not fare as well as its peers in the same industry. Since the market seems unimpressed with IVE Group, it's quite possible it could surprise on the upside. 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
Companies that shrink earnings per share quickly will rapidly decrease the 'E' in the equation. That means unless the share price falls, the P/E will increase in a few years. Then, a higher P/E might scare off shareholders, pushing the share price down.
IVE Group saw earnings per share decrease by 10% last year. But over the longer term (5 years) earnings per share have increased by 55%. And over the longer term (3 years) earnings per share have decreased 7.5% annually. This might lead to low expectations.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. That means it doesn't take debt or cash into account. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.
While growth expenditure doesn't always pay off, the point is that it is a good option to have; but one that the P/E ratio ignores.
So What Does IVE Group's Balance Sheet Tell Us?
IVE Group has net debt worth a very significant 141% of its market capitalization. This level of debt justifies a relatively low P/E, so remain cognizant of the debt, if you're comparing it to other stocks.
The Verdict On IVE Group's P/E Ratio
IVE Group's P/E is 3.5 which is below average (14.3) in the AU market. The P/E reflects market pessimism that probably arises from the lack of recent EPS growth, paired with significant leverage. What is very clear is that the market has become less pessimistic about IVE Group over the last month, with the P/E ratio rising from 2.7 back then to 3.5 today. For those who like to invest in turnarounds, that might mean it's time to put the stock on a watchlist, or research it. But others might consider the opportunity to have passed.
Investors should be looking to buy stocks that the market is wrong about. If the reality for a company is not as bad as the P/E ratio indicates, then the share price should increase as the market realizes this. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.
But note: IVE Group 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 email@example.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.
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