To the annoyance of some shareholders, Hiolle Industries (EPA:ALHIO) shares are down a considerable 36% in the last month. The recent drop has obliterated the annual return, with the share price now down 20% over that longer period.
Assuming nothing else has changed, a lower share price makes a stock more 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 long term investors have an opportunity when expectations of a company are too low. 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 Hiolle Industries Have A Relatively High Or Low P/E For Its Industry?
We can tell from its P/E ratio of 7.45 that sentiment around Hiolle Industries isn't particularly high. We can see in the image below that the average P/E (11.4) for companies in the machinery industry is higher than Hiolle Industries's P/E.
Hiolle Industries's P/E tells us that market participants think it will not fare as well as its peers in the same 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. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.
In the last year, Hiolle Industries grew EPS like Taylor Swift grew her fan base back in 2010; the 75% gain was both fast and well deserved. The sweetener is that the annual five year growth rate of 28% is also impressive. With that kind of growth rate we would generally expect a high P/E ratio.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. So it won't reflect the advantage of cash, or disadvantage of debt. The exact same company would hypothetically deserve a higher P/E ratio if it had a strong balance sheet, than if it had a weak one with lots of debt, because a cashed up company can spend on growth.
Such expenditure might be good or bad, in the long term, but the point here is that the balance sheet is not reflected by this ratio.
How Does Hiolle Industries's Debt Impact Its P/E Ratio?
The extra options and safety that comes with Hiolle Industries's €2.2m net cash position means that it deserves a higher P/E than it would if it had a lot of net debt.
The Bottom Line On Hiolle Industries's P/E Ratio
Hiolle Industries trades on a P/E ratio of 7.4, which is below the FR market average of 14.0. It grew its EPS nicely over the last year, and the healthy balance sheet implies there is more potential for growth. The below average P/E ratio suggests that market participants don't believe the strong growth will continue. What can be absolutely certain is that the market has become more pessimistic about Hiolle Industries over the last month, with the P/E ratio falling from 11.6 back then to 7.4 today. For those who prefer to invest with the flow of momentum, that might be a bad sign, but for deep value investors this stock might justify some research.
Investors should be looking to buy stocks that the market is wrong about. 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. We don't have analyst forecasts, but shareholders might want to examine this detailed historical graph of earnings, revenue and cash flow.
Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.
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.
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