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What Is PWR Holdings's (ASX:PWH) P/E Ratio After Its Share Price Tanked?

Simply Wall St

To the annoyance of some shareholders, PWR Holdings (ASX:PWH) shares are down a considerable 30% in the last month. Even longer term holders have taken a real hit with the stock declining 4.5% 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). 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). 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.

View our latest analysis for PWR Holdings

Does PWR Holdings Have A Relatively High Or Low P/E For Its Industry?

We can tell from its P/E ratio of 23.57 that there is some investor optimism about PWR Holdings. As you can see below, PWR Holdings has a higher P/E than the average company (12.1) in the auto components industry.

ASX:PWH Price Estimation Relative to Market, March 14th 2020
ASX:PWH Price Estimation Relative to Market, March 14th 2020

PWR Holdings's P/E tells us that market participants think the company will perform better than its industry peers, going forward. Shareholders are clearly optimistic, but the future is always uncertain. So further research is always essential. I often monitor director buying and selling.

How Growth Rates Impact P/E Ratios

Generally speaking the rate of earnings growth has a profound impact on a company's P/E multiple. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. 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.

PWR Holdings increased earnings per share by an impressive 20% over the last twelve months. And its annual EPS growth rate over 5 years is 5.9%. This could arguably justify a relatively high P/E ratio.

A Limitation: P/E Ratios Ignore Debt and Cash In The Bank

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. 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.

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.

Is Debt Impacting PWR Holdings's P/E?

Since PWR Holdings holds net cash of AU$4.1m, it can spend on growth, justifying a higher P/E ratio than otherwise.

The Verdict On PWR Holdings's P/E Ratio

PWR Holdings has a P/E of 23.6. That's higher than the average in its market, which is 14.9. With cash in the bank the company has plenty of growth options -- and it is already on the right track. Therefore it seems reasonable that the market would have relatively high expectations of the company Given PWR Holdings's P/E ratio has declined from 33.8 to 23.6 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.

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 visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.

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 editorial-team@simplywallst.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.