To the annoyance of some shareholders, Peab (STO:PEAB B) shares are down a considerable 33% in the last month. The recent drop has obliterated the annual return, with the share price now down 12% over that longer period.
All else being equal, a share price drop should make a stock more 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). 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). Investors have optimistic expectations of companies with higher P/E ratios, compared to companies with lower P/E ratios.
Does Peab Have A Relatively High Or Low P/E For Its Industry?
We can tell from its P/E ratio of 9.86 that sentiment around Peab isn't particularly high. We can see in the image below that the average P/E (14.0) for companies in the construction industry is higher than Peab's P/E.
Its relatively low P/E ratio indicates that Peab shareholders think it will struggle to do as well as other companies in its industry classification. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. You should delve deeper. I like to check if company insiders have been buying or selling.
How Growth Rates Impact P/E Ratios
Earnings growth rates have a big influence on P/E ratios. When earnings grow, the 'E' increases, over time. That means unless the share price increases, the P/E will reduce in a few years. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.
Peab maintained roughly steady earnings over the last twelve months. But EPS is up 15% over the last 5 years.
Remember: P/E Ratios Don't Consider The Balance Sheet
The 'Price' in P/E reflects the market capitalization of the company. In other words, it does not consider any debt or cash that the company may have on the balance sheet. 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 Peab's Debt Impact Its P/E Ratio?
Net debt is 30% of Peab's market cap. You'd want to be aware of this fact, but it doesn't bother us.
The Bottom Line On Peab's P/E Ratio
Peab trades on a P/E ratio of 9.9, which is below the SE market average of 14.5. With only modest debt, it's likely the lack of EPS growth at least partially explains the pessimism implied by the P/E ratio. What can be absolutely certain is that the market has become more pessimistic about Peab over the last month, with the P/E ratio falling from 14.7 back then to 9.9 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. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.
But note: Peab 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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