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Renewable Energy Group (NASDAQ:REGI) shares have retraced a considerable 30% in the last month. The recent drop has obliterated the annual return, with the share price now down 17% over that longer period. But those shareholders who nailed the timing of their purchase will be quite happy; the stock has gained 9.0% in the last 90 days.
Assuming nothing else has changed, a lower share price makes a stock more attractive to potential buyers. While the market sentiment towards a stock is very changeable, in the long run, the share price will tend to move in the same direction as earnings per share. The implication here is that long term investors have an opportunity when expectations of a company are too low. Perhaps the simplest way to get a read on investors' expectations of a business 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 Renewable Energy Group's P/E Ratio Compare To Its Peers?
We can tell from its P/E ratio of 1.95 that sentiment around Renewable Energy Group isn't particularly high. We can see in the image below that the average P/E (6.7) for companies in the oil and gas industry is higher than Renewable Energy Group's P/E.
Renewable Energy Group's P/E tells us that market participants think it will not fare as well as its peers in the same industry. Since the market seems unimpressed with Renewable Energy Group, it's quite possible it could surprise on the upside. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.
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. That's because companies that grow earnings per share quickly will rapidly increase the 'E' in the equation. That means unless the share price increases, the P/E will reduce in a few years. Then, a lower P/E should attract more buyers, pushing the share price up.
It's nice to see that Renewable Energy Group grew EPS by a stonking 27% in the last year. And its annual EPS growth rate over 5 years is 38%. So we'd generally expect it to have a relatively high P/E ratio.
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 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.
So What Does Renewable Energy Group's Balance Sheet Tell Us?
Net debt totals 17% of Renewable Energy Group's market cap. It would probably deserve a higher P/E ratio if it was net cash, since it would have more options for growth.
The Bottom Line On Renewable Energy Group's P/E Ratio
Renewable Energy Group trades on a P/E ratio of 1.9, which is below the US market average of 13.3. The company hasn't stretched its balance sheet, and earnings growth was good last year. If the company can continue to grow earnings, then the current P/E may be unjustifiably low. Given Renewable Energy Group's P/E ratio has declined from 2.8 to 1.9 in the last month, we know for sure that the market is more worried 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 deep value investors this stock might justify some research.
Investors have an opportunity when market expectations about a stock are wrong. As value investor Benjamin Graham famously said, 'In the short run, the market is a voting machine but in the long run, it is a weighing machine. 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 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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