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Read This Before You Buy Oconee Federal Financial Corp. (NASDAQ:OFED) Because Of Its P/E Ratio

Simply Wall St

Of late the Oconee Federal Financial (NASDAQ:OFED) share price has softened like an ice cream in the sun, melting a full . But plenty of shareholders will still be smiling, given that the stock is up 20% over the last quarter. Looking back further, the stock is up 7.0% in the last year.

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). Investors have optimistic expectations of companies with higher P/E ratios, compared to companies with lower P/E ratios.

See our latest analysis for Oconee Federal Financial

Does Oconee Federal Financial Have A Relatively High Or Low P/E For Its Industry?

We can tell from its P/E ratio of 40.87 that there is some investor optimism about Oconee Federal Financial. The image below shows that Oconee Federal Financial has a higher P/E than the average (14.2) P/E for companies in the mortgage industry.

NasdaqCM:OFED Price Estimation Relative to Market, January 16th 2020

That means that the market expects Oconee Federal Financial 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

If earnings fall then in the future the 'E' will be lower. Therefore, even if you pay a low multiple of earnings now, that multiple will become higher in the future. A higher P/E should indicate the stock is expensive relative to others -- and that may encourage shareholders to sell.

Oconee Federal Financial increased earnings per share by an impressive 24% over the last twelve months. Unfortunately, earnings per share are down 9.1% a year, over 3 years.

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

The 'Price' in P/E reflects the market capitalization of the company. So it won't reflect the advantage of cash, or disadvantage of debt. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.

Such expenditure might be good or bad, in the long term, but the point here is that the balance sheet is not reflected by this ratio.

Oconee Federal Financial's Balance Sheet

Oconee Federal Financial has net cash of US$23m. This is fairly high at 15% of its market capitalization. That might mean balance sheet strength is important to the business, but should also help push the P/E a bit higher than it would otherwise be.

The Verdict On Oconee Federal Financial's P/E Ratio

Oconee Federal Financial has a P/E of 40.9. That's higher than the average in its market, which is 18.9. With cash in the bank the company has plenty of growth options -- and it is already on the right track. So it does not seem strange that the P/E is above average. Given Oconee Federal Financial's P/E ratio has declined from 40.9 to 40.9 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.

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. We don't have analyst forecasts, but you might want to assess this data-rich visualization of earnings, revenue and cash flow.

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.