To the annoyance of some shareholders, Pareto Bank (OB:PARB) shares are down a considerable 41% in the last month. That drop has capped off a tough year for shareholders, with the share price down 30% in that time.
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). A high P/E ratio means that investors have a high expectation about future growth, while a low P/E ratio means they have low expectations about future growth.
How Does Pareto Bank's P/E Ratio Compare To Its Peers?
We can tell from its P/E ratio of 4.56 that sentiment around Pareto Bank isn't particularly high. If you look at the image below, you can see Pareto Bank has a lower P/E than the average (6.6) in the banks industry classification.
This suggests that market participants think Pareto Bank will underperform other companies in its industry. Many investors like to buy stocks when the market is pessimistic about their prospects. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and selling.
How Growth Rates Impact P/E Ratios
Earnings growth rates have a big influence on P/E ratios. 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. Then, a lower P/E should attract more buyers, pushing the share price up.
Pareto Bank maintained roughly steady earnings over the last twelve months. But EPS is up 8.9% over the last 5 years.
Remember: P/E Ratios Don't Consider The Balance Sheet
Don't forget that the P/E ratio considers market capitalization. That means it doesn't take debt or cash into account. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.
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 Pareto Bank's Debt Impact Its P/E Ratio?
Net debt totals a substantial 278% of Pareto Bank's market cap. If you want to compare its P/E ratio to other companies, you must keep in mind that these debt levels would usually warrant a relatively low P/E.
The Bottom Line On Pareto Bank's P/E Ratio
Pareto Bank trades on a P/E ratio of 4.6, which is below the NO market average of 9.6. The meaningful debt load is probably contributing to low expectations, even though it has improved earnings recently. What can be absolutely certain is that the market has become more pessimistic about Pareto Bank over the last month, with the P/E ratio falling from 7.7 back then to 4.6 today. For those who prefer invest in growth, this stock apparently offers limited promise, but the deep value investors may find the pessimism around this stock enticing.
Investors have an opportunity when market expectations about a stock are wrong. 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. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.
Of course you might be able to find a better stock than Pareto Bank. So you may wish to see this free collection of other companies that have grown earnings strongly.
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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