Unfortunately for some shareholders, the Espey Mfg. & Electronics (NYSEMKT:ESP) share price has dived in the last thirty days. Even longer term holders have taken a real hit with the stock declining 17% 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). So some would prefer to hold off buying when there is a lot of optimism towards a stock. 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.
Does Espey Mfg. & Electronics Have A Relatively High Or Low P/E For Its Industry?
We can tell from its P/E ratio of 21.03 that there is some investor optimism about Espey Mfg. & Electronics. You can see in the image below that the average P/E (18.8) for companies in the electrical industry is lower than Espey Mfg. & Electronics's P/E.
Its relatively high P/E ratio indicates that Espey Mfg. & Electronics shareholders think it will perform better than other companies in its industry classification. The market is optimistic about the future, but that doesn't guarantee future growth. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.
How Growth Rates Impact P/E Ratios
When earnings fall, the 'E' decreases, over time. That means unless the share price falls, the P/E will increase in a few years. So while a stock may look cheap based on past earnings, it could be expensive based on future earnings.
Espey Mfg. & Electronics shrunk earnings per share by 14% over the last year. But it has grown its earnings per share by 17% per year over the last five years. And EPS is down 5.8% a year, over the last 3 years. This growth rate might warrant a low P/E ratio.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
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. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
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.
Is Debt Impacting Espey Mfg. & Electronics's P/E?
Espey Mfg. & Electronics has net cash of US$10m. This is fairly high at 20% 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 Espey Mfg. & Electronics's P/E Ratio
Espey Mfg. & Electronics has a P/E of 21.0. That's higher than the average in its market, which is 18.7. The recent drop in earnings per share might keep value investors away, but the net cash position means the company has time to improve: and the high P/E suggests the market thinks it will. Given Espey Mfg. & Electronics's P/E ratio has declined from 21.0 to 21.0 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 have an opportunity when market expectations about a stock are wrong. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. We don't have analyst forecasts, but shareholders might want to examine this detailed historical graph of earnings, revenue and cash flow.
But note: Espey Mfg. & Electronics 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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