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Read This Before You Buy Ocean Bio-Chem, Inc. (NASDAQ:OBCI) Because Of Its P/E Ratio

Simply Wall St

Ocean Bio-Chem (NASDAQ:OBCI) shares have given back plenty of recent gains in the last month, dropping . Indeed, the recent drop has reduced the annual gain to a relatively sedate 4.9% over the last twelve months.

Assuming no other changes, a sharply higher share price makes a stock less attractive to potential buyers. 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). 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.

See our latest analysis for Ocean Bio-Chem

How Does Ocean Bio-Chem's P/E Ratio Compare To Its Peers?

We can tell from its P/E ratio of 11.71 that sentiment around Ocean Bio-Chem isn't particularly high. If you look at the image below, you can see Ocean Bio-Chem has a lower P/E than the average (25.8) in the household products industry classification.

NasdaqCM:OBCI Price Estimation Relative to Market, December 12th 2019

Its relatively low P/E ratio indicates that Ocean Bio-Chem shareholders think it will struggle to do as well as other companies in its industry classification. Since the market seems unimpressed with Ocean Bio-Chem, it's quite possible it could surprise on the upside. You should delve deeper. I like to check if company insiders have been buying or selling.

How Growth Rates Impact P/E Ratios

Earnings growth rates have a big influence on P/E ratios. Earnings growth means that in the future the 'E' will be higher. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.

Ocean Bio-Chem's earnings per share fell by 16% in the last twelve months. But it has grown its earnings per share by 6.6% per year over the last five years.

Remember: P/E Ratios Don't Consider The Balance Sheet

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. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.

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 Ocean Bio-Chem's P/E?

Net debt totals just 7.8% of Ocean Bio-Chem's market cap. It would probably trade on a higher P/E ratio if it had a lot of cash, but I doubt it is having a big impact.

The Verdict On Ocean Bio-Chem's P/E Ratio

Ocean Bio-Chem trades on a P/E ratio of 11.7, which is below the US market average of 18.4. Since it only carries a modest debt load, it's likely the low expectations implied by the P/E ratio arise from the lack of recent earnings growth. What can be absolutely certain is that the market has become less optimistic about Ocean Bio-Chem over the last month, with the P/E ratio falling from 11.7 back then to 11.7 today. 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 not as bad as the P/E ratio indicates, then the share price should increase as the market realizes this. 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 Ocean Bio-Chem. 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.