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A Rising Share Price Has Us Looking Closely At Renewable Energy Group, Inc.'s (NASDAQ:REGI) P/E Ratio

Simply Wall St

Those holding Renewable Energy Group (NASDAQ:REGI) shares must be pleased that the share price has rebounded 34% in the last thirty days. But unfortunately, the stock is still down by 5.7% over a quarter. While recent buyers might be laughing, long term holders might not be so pleased, since the recent gain only brings the full year return to evens.

All else being equal, a sharp share price increase should make a stock less attractive to potential investors. 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. 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 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.

Check out our latest analysis for Renewable Energy Group

How Does Renewable Energy Group's P/E Ratio Compare To Its Peers?

Renewable Energy Group's P/E of 2.46 indicates relatively low sentiment towards the stock. If you look at the image below, you can see Renewable Energy Group has a lower P/E than the average (8.6) in the oil and gas industry classification.

NasdaqGS:REGI Price Estimation Relative to Market April 28th 2020

This suggests that market participants think Renewable Energy Group will underperform other companies in its industry. Many investors like to buy stocks when the market is pessimistic about their prospects. 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. 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. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.

Notably, Renewable Energy Group grew EPS by a whopping 27% in the last year. And it has bolstered its earnings per share by 38% per year over the last five years. So we'd generally expect it to have a relatively high P/E ratio.

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

It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. In other words, it does not consider any debt or cash that the company may have on the balance sheet. 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 Renewable Energy Group's P/E?

Renewable Energy Group has net debt worth 13% of its market capitalization. That's enough debt to impact the P/E ratio a little; so keep it in mind if you're comparing it to companies without debt.

The Verdict On Renewable Energy Group's P/E Ratio

Renewable Energy Group has a P/E of 2.5. That's below the average in the US market, which is 14.0. The company hasn't stretched its balance sheet, and earnings growth was good last year. The low P/E ratio suggests current market expectations are muted, implying these levels of growth will not continue. What is very clear is that the market has become less pessimistic about Renewable Energy Group over the last month, with the P/E ratio rising from 1.8 back then to 2.5 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.

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. So this free report on the analyst consensus forecasts could help you make a master move on this stock.

But note: Renewable Energy Group may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio 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.