Those holding M.D.C. Holdings (NYSE:MDC) shares must be pleased that the share price has rebounded 42% in the last thirty days. But unfortunately, the stock is still down by 33% over a quarter. But shareholders may not all be feeling jubilant, since the share price is still down 11% 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). 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.
Does M.D.C. Holdings Have A Relatively High Or Low P/E For Its Industry?
M.D.C. Holdings's P/E of 7.50 indicates relatively low sentiment towards the stock. The image below shows that M.D.C. Holdings has a lower P/E than the average (8.2) P/E for companies in the consumer durables industry.
M.D.C. Holdings'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 M.D.C. Holdings, 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
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.
M.D.C. Holdings increased earnings per share by an impressive 11% over the last twelve months. And earnings per share have improved by 29% annually, over the last five years. This could arguably justify a relatively high P/E ratio.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
The 'Price' in P/E reflects the market capitalization of the company. In other words, it does not consider any debt or cash that the company may have on the balance sheet. 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).
Spending on growth might be good or bad a few years later, but the point is that the P/E ratio does not account for the option (or lack thereof).
M.D.C. Holdings's Balance Sheet
M.D.C. Holdings has net debt equal to 40% of its market cap. You'd want to be aware of this fact, but it doesn't bother us.
The Verdict On M.D.C. Holdings's P/E Ratio
M.D.C. Holdings trades on a P/E ratio of 7.5, which is below the US market average of 14.4. The EPS growth last year was strong, and debt levels are quite reasonable. If it continues to grow, then the current low P/E may prove to be unjustified. What is very clear is that the market has become less pessimistic about M.D.C. Holdings over the last month, with the P/E ratio rising from 5.3 back then to 7.5 today. 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.
When the market is wrong about a stock, it gives savvy investors an opportunity. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.
Of course you might be able to find a better stock than M.D.C. Holdings. 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 firstname.lastname@example.org. 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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