U.S. Markets closed

A Rising Share Price Has Us Looking Closely At Primero Group Limited's (ASX:PGX) P/E Ratio

Simply Wall St

Those holding Primero Group (ASX:PGX) shares must be pleased that the share price has rebounded 31% in the last thirty days. But unfortunately, the stock is still down by 35% over a quarter. But shareholders may not all be feeling jubilant, since the share price is still down 32% 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). 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.

See our latest analysis for Primero Group

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

Primero Group's P/E of 6.95 indicates relatively low sentiment towards the stock. The image below shows that Primero Group has a lower P/E than the average (16.5) P/E for companies in the construction industry.

ASX:PGX Price Estimation Relative to Market May 12th 2020

This suggests that market participants think Primero Group will underperform other companies in its industry. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and selling.

How Growth Rates Impact P/E Ratios

Probably the most important factor in determining what P/E a company trades on is the earnings growth. That's because companies that grow earnings per share quickly will rapidly increase the 'E' in the equation. That means even if the current P/E is high, it will reduce over time if the share price stays flat. And as that P/E ratio drops, the company will look cheap, unless its share price increases.

Primero Group's earnings per share fell by 11% in the last twelve months. But it has grown its earnings per share by 44% per year over the last three years.

Remember: P/E Ratios Don't Consider The Balance Sheet

It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. That means it doesn't take debt or cash into account. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.

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.

So What Does Primero Group's Balance Sheet Tell Us?

Primero Group has net cash of AU$159k. That should lead to a higher P/E than if it did have debt, because its strong balance sheets gives it more options.

The Bottom Line On Primero Group's P/E Ratio

Primero Group has a P/E of 6.9. That's below the average in the AU market, which is 15.4. The recent drop in earnings per share would make investors cautious, but the net cash position means the company has time to improve: if so, the low P/E could be an opportunity. What we know for sure is that investors are becoming less uncomfortable about Primero Group's prospects, since they have pushed its P/E ratio from 5.3 to 6.9 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.

When the market is wrong about a stock, it gives savvy investors an opportunity. If the reality for a company is not as bad as the P/E ratio indicates, then the share price should increase as the market realizes this. 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 be able to find a better stock than Primero Group. 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 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.