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Read This Before You Buy New England Realty Associates Limited Partnership (NYSEMKT:NEN) Because Of Its P/E Ratio

Simply Wall St

Of late the New England Realty Associates Limited Partnership (NYSEMKT:NEN) share price has softened like an ice cream in the sun, melting a full . But there's still good reason for shareholders to be content; the stock has gained 5.6% in the last 90 days. The stock has been solid, longer term, gaining 11% in the last year.

All else being equal, a sharp share price increase should make a stock less 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 some would prefer to hold off buying when there is a lot of optimism towards a stock. 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.

Check out our latest analysis for New England Realty Associates Limited Partnership

How Does New England Realty Associates Limited Partnership's P/E Ratio Compare To Its Peers?

New England Realty Associates Limited Partnership's P/E of 36.47 indicates some degree of optimism towards the stock. As you can see below, New England Realty Associates Limited Partnership has a higher P/E than the average company (27.3) in the real estate industry.

AMEX:NEN Price Estimation Relative to Market, December 23rd 2019

That means that the market expects New England Realty Associates Limited Partnership will outperform other companies in its industry. The market is optimistic about the future, but that doesn't guarantee future growth. 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

P/E ratios primarily reflect market expectations around earnings growth rates. When earnings grow, the 'E' increases, over time. 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.

New England Realty Associates Limited Partnership increased earnings per share by a whopping 47% last year. And earnings per share have improved by 54% annually, over the last five years. I'd therefore be a little surprised if its P/E ratio was not relatively high.

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

The 'Price' in P/E reflects the market capitalization of the company. Thus, the metric does not reflect cash or debt held by the company. Theoretically, a business can improve its earnings (and produce a lower P/E in the future) by investing in growth. That means taking on debt (or spending its cash).

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.

New England Realty Associates Limited Partnership's Balance Sheet

Net debt totals a substantial 105% of New England Realty Associates Limited Partnership's market cap. This is a relatively high level of debt, so the stock probably deserves a relatively low P/E ratio. Keep that in mind when comparing it to other companies.

The Verdict On New England Realty Associates Limited Partnership's P/E Ratio

New England Realty Associates Limited Partnership has a P/E of 36.5. That's higher than the average in its market, which is 18.9. Its meaningful level of debt should warrant a lower P/E ratio, but the fast EPS growth is a positive. So despite the debt it is, perhaps, not unreasonable to see a high P/E ratio. Given New England Realty Associates Limited Partnership's P/E ratio has declined from 36.5 to 36.5 in the last month, we know for sure that the market is 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. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. Although we don't have analyst forecasts shareholders might want to examine this detailed historical graph of earnings, revenue and cash flow.

Of course you might be able to find a better stock than New England Realty Associates Limited Partnership. 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 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.