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What Is Kip McGrath Education Centres's (ASX:KME) P/E Ratio After Its Share Price Tanked?

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Simply Wall St
·4 min read
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Unfortunately for some shareholders, the Kip McGrath Education Centres (ASX:KME) share price has dived 40% in the last thirty days. Even longer term holders have taken a real hit with the stock declining 6.2% in the last year.

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). So, on certain occasions, long term focussed investors try to take advantage of pessimistic expectations to buy shares at a better price. 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.

Check out our latest analysis for Kip McGrath Education Centres

How Does Kip McGrath Education Centres's P/E Ratio Compare To Its Peers?

Kip McGrath Education Centres's P/E of 16.04 indicates relatively low sentiment towards the stock. If you look at the image below, you can see Kip McGrath Education Centres has a lower P/E than the average (23.5) in the consumer services industry classification.

ASX:KME Price Estimation Relative to Market, February 28th 2020
ASX:KME Price Estimation Relative to Market, February 28th 2020

This suggests that market participants think Kip McGrath Education Centres will underperform other companies in its industry. Many investors like to buy stocks when the market is pessimistic about their prospects. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.

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. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. And in that case, the P/E ratio itself will drop rather quickly. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.

Kip McGrath Education Centres saw earnings per share decrease by 1.3% last year. But over the longer term (5 years) earnings per share have increased by 19%.

Don't Forget: The P/E Does Not Account For Debt or Bank Deposits

Don't forget that the P/E ratio considers market capitalization. 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).

Such expenditure might be good or bad, in the long term, but the point here is that the balance sheet is not reflected by this ratio.

How Does Kip McGrath Education Centres's Debt Impact Its P/E Ratio?

The extra options and safety that comes with Kip McGrath Education Centres's AU$3.9m net cash position means that it deserves a higher P/E than it would if it had a lot of net debt.

The Verdict On Kip McGrath Education Centres's P/E Ratio

Kip McGrath Education Centres has a P/E of 16.0. That's below the average in the AU market, which is 18.0. Falling earnings per share are likely to be keeping potential buyers away, but the net cash position means the company has time to improve: if so, the low P/E could be an opportunity. Given Kip McGrath Education Centres's P/E ratio has declined from 26.8 to 16.0 in the last month, we know for sure that the market is significantly 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 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. 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 Kip McGrath Education Centres. 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.