To the annoyance of some shareholders, MAXIMUS (NYSE:MMS) shares are down a considerable 32% in the last month. That drop has capped off a tough year for shareholders, with the share price down 31% in that time.
All else being equal, a share price drop should make a stock more attractive to potential investors. While the market sentiment towards a stock is very changeable, in the long run, the share price will tend to move in the same direction as earnings per share. So, on certain occasions, long term focussed investors try to take advantage of pessimistic expectations to buy shares at a better price. 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 MAXIMUS's P/E Ratio Compare To Its Peers?
We can tell from its P/E ratio of 13.08 that sentiment around MAXIMUS isn't particularly high. We can see in the image below that the average P/E (24.2) for companies in the it industry is higher than MAXIMUS's P/E.
Its relatively low P/E ratio indicates that MAXIMUS 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. That's because companies that grow earnings per share quickly will rapidly increase the 'E' in the equation. That means even if the current P/E is high, it will reduce over time if the share price stays flat. Then, a lower P/E should attract more buyers, pushing the share price up.
MAXIMUS increased earnings per share by an impressive 13% over the last twelve months. And its annual EPS growth rate over 5 years is 11%. With that performance, you might expect an above average P/E ratio.
Remember: P/E Ratios Don't Consider The Balance Sheet
It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. That means it doesn't take debt or cash into account. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
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.
Is Debt Impacting MAXIMUS's P/E?
Since MAXIMUS holds net cash of US$143m, it can spend on growth, justifying a higher P/E ratio than otherwise.
The Bottom Line On MAXIMUS's P/E Ratio
MAXIMUS has a P/E of 13.1. That's around the same as the average in the US market, which is 12.7. Considering its recent growth, alongside its lack of debt, it would appear that the market isn't very excited about the future. Given MAXIMUS's P/E ratio has declined from 19.3 to 13.1 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 prefer to invest with the flow of momentum, that might be a bad sign, but for a contrarian, it may signal opportunity.
Investors should be looking to buy stocks that the market is wrong about. People often underestimate remarkable growth -- so investors can make money when fast growth is not fully appreciated. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.
You might be able to find a better buy than MAXIMUS. 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 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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