To the annoyance of some shareholders, Fortum Oyj (HEL:FORTUM) shares are down a considerable 43% in the last month. That drop has capped off a tough year for shareholders, with the share price down 34% in that time.
All else being equal, a share price drop should make a stock more attractive to potential investors. 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. 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 implies that investors have high expectations of what a company can achieve compared to a company with a low P/E ratio.
How Does Fortum Oyj's P/E Ratio Compare To Its Peers?
We can tell from its P/E ratio of 7.77 that sentiment around Fortum Oyj isn't particularly high. We can see in the image below that the average P/E (10.2) for companies in the electric utilities industry is higher than Fortum Oyj's P/E.
This suggests that market participants think Fortum Oyj will underperform other companies in its industry. Since the market seems unimpressed with Fortum Oyj, 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. 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.
In the last year, Fortum Oyj grew EPS like Taylor Swift grew her fan base back in 2010; the 76% gain was both fast and well deserved. And earnings per share have improved by 44% annually, over the last three years. So we'd absolutely expect it to have a relatively high P/E ratio.
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. Thus, the metric does not reflect cash or debt held by the company. 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.
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).
How Does Fortum Oyj's Debt Impact Its P/E Ratio?
Fortum Oyj's net debt equates to 45% of its market capitalization. You'd want to be aware of this fact, but it doesn't bother us.
The Bottom Line On Fortum Oyj's P/E Ratio
Fortum Oyj trades on a P/E ratio of 7.8, which is below the FI market average of 14.6. The company does have a little debt, and EPS growth was good last year. If the company can continue to grow earnings, then the current P/E may be unjustifiably low. Given Fortum Oyj's P/E ratio has declined from 13.6 to 7.8 in the last month, we know for sure that the market is more worried about the business today, than it was back then. For those who prefer invest in growth, this stock apparently offers limited promise, but the deep value investors may find the pessimism around this stock enticing.
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 visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.
But note: Fortum Oyj 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 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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