Ricegrowers (ASX:SGLLV) shareholders are no doubt pleased to see that the share price has had a great month, posting a 31% gain, recovering from prior weakness. Longer term shareholders are no doubt thankful for the recovery in the share price, since it's pretty much flat for the year, even after the recent pop.
Assuming no other changes, a sharply higher share price makes a stock less 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 deep value investors might steer clear when expectations of a company are too high. 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.
Does Ricegrowers Have A Relatively High Or Low P/E For Its Industry?
We can tell from its P/E ratio of 8.16 that sentiment around Ricegrowers isn't particularly high. We can see in the image below that the average P/E (22.7) for companies in the food industry is higher than Ricegrowers's P/E.
Its relatively low P/E ratio indicates that Ricegrowers shareholders think it will struggle to do as well as other companies in its industry classification. Since the market seems unimpressed with Ricegrowers, 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
Companies that shrink earnings per share quickly will rapidly decrease the 'E' in the equation. That means unless the share price falls, the P/E will increase in a few years. Then, a higher P/E might scare off shareholders, pushing the share price down.
Ricegrowers shrunk earnings per share by 2.3% last year. And EPS is down 2.3% a year, over the last 5 years. So we might expect a relatively low P/E.
Remember: P/E Ratios Don't Consider The Balance Sheet
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 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.
Is Debt Impacting Ricegrowers's P/E?
Net debt is 42% of Ricegrowers's market cap. While it's worth keeping this in mind, it isn't a worry.
The Bottom Line On Ricegrowers's P/E Ratio
Ricegrowers has a P/E of 8.2. That's below the average in the AU market, which is 18.8. The debt levels are not a major concern, but the lack of EPS growth is likely weighing on sentiment. What we know for sure is that investors are becoming less uncomfortable about Ricegrowers's prospects, since they have pushed its P/E ratio from 6.2 to 8.2 over the last month. If you like to buy stocks that could be turnaround opportunities, then this one might be a candidate; but if you're more sensitive to price, then you may feel the opportunity has passed.
Investors should be looking to buy stocks that the market is wrong about. 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. Although we don't have analyst forecasts you could get a better understanding of its growth by checking out this more detailed historical graph of earnings, revenue and cash flow.
You might be able to find a better buy than Ricegrowers. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
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.
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.