To the annoyance of some shareholders, Ormat Technologies (NYSE:ORA) shares are down a considerable 31% in the last month. Looking back further, the stock is up 5.6% in the last year.
Assuming nothing else has changed, a lower share price makes a stock more attractive to potential buyers. 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. The implication here is that long term investors have an opportunity when expectations of a company are too low. 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 Ormat Technologies's P/E Ratio Compare To Its Peers?
We can tell from its P/E ratio of 33.76 that there is some investor optimism about Ormat Technologies. You can see in the image below that the average P/E (29.6) for companies in the renewable energy industry is lower than Ormat Technologies's P/E.
Ormat Technologies's P/E tells us that market participants think the company will perform better than its industry peers, going forward. Clearly the market expects growth, but it isn't guaranteed. 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
Companies that shrink earnings per share quickly will rapidly decrease the 'E' in the equation. That means even if the current P/E is low, it will increase over time if the share price stays flat. Then, a higher P/E might scare off shareholders, pushing the share price down.
Ormat Technologies shrunk earnings per share by 10% over the last year. But over the longer term (5 years) earnings per share have increased by 7.8%. And over the longer term (3 years) earnings per share have decreased 1.2% annually. This growth rate might warrant a low P/E ratio.
Remember: P/E Ratios Don't Consider The Balance Sheet
Don't forget that the P/E ratio considers market capitalization. Thus, the metric does not reflect cash or debt held by the company. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.
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.
So What Does Ormat Technologies's Balance Sheet Tell Us?
Net debt is 39% of Ormat Technologies's market cap. While that's enough to warrant consideration, it doesn't really concern us.
The Bottom Line On Ormat Technologies's P/E Ratio
Ormat Technologies trades on a P/E ratio of 33.8, which is above its market average of 13.3. With a bit of debt, but a lack of recent growth, it's safe to say the market is expecting improved profit performance from the company, in the next few years. Given Ormat Technologies's P/E ratio has declined from 49.3 to 33.8 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.
When the market is wrong about a stock, it gives savvy investors an opportunity. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.
But note: Ormat 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 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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