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Barrett Business Services (NASDAQ:BBSI) shareholders are no doubt pleased to see that the share price has bounced 32% in the last month alone, although it is still down 52% over the last quarter. But shareholders may not all be feeling jubilant, since the share price is still down 43% in the last year.
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.
Does Barrett Business Services Have A Relatively High Or Low P/E For Its Industry?
We can tell from its P/E ratio of 6.64 that sentiment around Barrett Business Services isn't particularly high. If you look at the image below, you can see Barrett Business Services has a lower P/E than the average (14.6) in the professional services industry classification.
Barrett Business Services'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 Barrett Business Services, 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. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. And in that case, the P/E ratio itself will drop rather quickly. And as that P/E ratio drops, the company will look cheap, unless its share price increases.
Barrett Business Services increased earnings per share by a whopping 25% last year. And earnings per share have improved by 36% annually, over the last three years. I'd therefore be a little surprised if its P/E ratio was not relatively high.
Remember: P/E Ratios Don't Consider The Balance Sheet
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. 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).
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 Barrett Business Services's P/E?
With net cash of US$123m, Barrett Business Services has a very strong balance sheet, which may be important for its business. Having said that, at 38% of its market capitalization the cash hoard would contribute towards a higher P/E ratio.
The Verdict On Barrett Business Services's P/E Ratio
Barrett Business Services trades on a P/E ratio of 6.6, which is below the US market average of 13.6. Not only should the net cash position reduce risk, but the recent growth has been impressive. The below average P/E ratio suggests that market participants don't believe the strong growth will continue. What we know for sure is that investors are becoming less uncomfortable about Barrett Business Services's prospects, since they have pushed its P/E ratio from 5.0 to 6.6 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. So this free report on the analyst consensus forecasts could help you make a master move on this stock.
Of course you might be able to find a better stock than Barrett Business Services. 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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