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To the annoyance of some shareholders, Provident Financial Holdings (NASDAQ:PROV) shares are down a considerable 35% in the last month. That drop has capped off a tough year for shareholders, with the share price down 37% 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 implies that investors have high expectations of what a company can achieve compared to a company with a low P/E ratio.
How Does Provident Financial Holdings's P/E Ratio Compare To Its Peers?
Provident Financial Holdings's P/E of 17.02 indicates some degree of optimism towards the stock. The image below shows that Provident Financial Holdings has a higher P/E than the average (10.4) P/E for companies in the mortgage industry.
That means that the market expects Provident Financial Holdings will outperform other companies in its industry. The market is optimistic about the future, but that doesn't guarantee future growth. So further research is always essential. I often monitor director buying and selling.
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.
Provident Financial Holdings's earnings per share fell by 19% in the last twelve months. And over the longer term (5 years) earnings per share have decreased 3.0% annually. This might lead to muted expectations.
Remember: P/E Ratios Don't Consider The Balance Sheet
The 'Price' in P/E reflects the market capitalization of the company. That means it doesn't take debt or cash into account. The exact same company would hypothetically deserve a higher P/E ratio if it had a strong balance sheet, than if it had a weak one with lots of debt, because a cashed up company can spend on growth.
Such spending might be good or bad, overall, but the key point here is that you need to look at debt to understand the P/E ratio in context.
So What Does Provident Financial Holdings's Balance Sheet Tell Us?
Provident Financial Holdings's net debt is 86% of its market cap. If you want to compare its P/E ratio to other companies, you should absolutely keep in mind it has significant borrowings.
The Verdict On Provident Financial Holdings's P/E Ratio
Provident Financial Holdings's P/E is 17.0 which is above average (12.9) in its market. With significant debt and no EPS growth last year, shareholders are betting on an improvement in earnings from the company. Given Provident Financial Holdings's P/E ratio has declined from 26.1 to 17.0 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.
Investors have an opportunity when market expectations about a stock are wrong. 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.
Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E 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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