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Unfortunately for some shareholders, the Napco Security Technologies (NASDAQ:NSSC) share price has dived 31% in the last thirty days. Even longer term holders have taken a real hit with the stock declining 23% 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.
How Does Napco Security Technologies's P/E Ratio Compare To Its Peers?
Napco Security Technologies's P/E of 20.28 indicates some degree of optimism towards the stock. As you can see below, Napco Security Technologies has a higher P/E than the average company (14.0) in the electronic industry.
Its relatively high P/E ratio indicates that Napco Security Technologies shareholders think it will perform better than other companies in its industry classification. Clearly the market expects growth, but it isn't guaranteed. So further research is always essential. I often monitor director buying and selling.
How Growth Rates Impact P/E Ratios
P/E ratios primarily reflect market expectations around earnings growth rates. Earnings growth means that in the future the 'E' will be higher. That means unless the share price increases, the P/E will reduce in a few years. And as that P/E ratio drops, the company will look cheap, unless its share price increases.
It's nice to see that Napco Security Technologies grew EPS by a stonking 50% in the last year. And it has bolstered its earnings per share by 30% per year over the last five years. So we'd generally expect it to have a relatively high P/E ratio.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
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.
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.
How Does Napco Security Technologies's Debt Impact Its P/E Ratio?
Napco Security Technologies has net cash of US$12m. That should lead to a higher P/E than if it did have debt, because its strong balance sheets gives it more options.
The Verdict On Napco Security Technologies's P/E Ratio
Napco Security Technologies trades on a P/E ratio of 20.3, which is above its market average of 13.3. Its net cash position is the cherry on top of its superb EPS growth. So based on this analysis we'd expect Napco Security Technologies to have a high P/E ratio. What can be absolutely certain is that the market has become significantly less optimistic about Napco Security Technologies over the last month, with the P/E ratio falling from 29.4 back then to 20.3 today. 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. As value investor Benjamin Graham famously said, 'In the short run, the market is a voting machine but in the long run, it is a weighing machine. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.
But note: Napco Security Technologies 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.
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.