Unfortunately for some shareholders, the Savills (LON:SVS) share price has dived 34% in the last thirty days. Even longer term holders have taken a real hit with the stock declining 15% in the last year.
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). 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 Savills's P/E Ratio Compare To Its Peers?
Savills has a P/E ratio of 12.75. You can see in the image below that the average P/E (12.2) for companies in the real estate industry is roughly the same as Savills's P/E.
That indicates that the market expects Savills will perform roughly in line with other companies in its industry. If the company has better than average prospects, then the market might be underestimating it. Checking factors such as director buying and selling. could help you form your own view on if that will happen.
How Growth Rates Impact P/E Ratios
Generally speaking the rate of earnings growth has a profound impact on a company's P/E multiple. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. That means even if the current P/E is high, it will reduce over time if the share price stays flat. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.
Savills saw earnings per share improve by 7.8% last year. And its annual EPS growth rate over 5 years is 5.3%.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
Don't forget that the P/E ratio considers market capitalization. Thus, the metric does not reflect cash or debt held by the company. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
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.
How Does Savills's Debt Impact Its P/E Ratio?
Savills has net cash of UK£29m. That should lead to a higher P/E than if it did have debt, because its strong balance sheets gives it more options.
The Verdict On Savills's P/E Ratio
Savills's P/E is 12.7 which is about average (12.5) in the GB market. Recent earnings growth wasn't bad. And the healthy balance sheet means the company can sustain growth. But the P/E suggests shareholders have some doubts. What can be absolutely certain is that the market has become significantly less optimistic about Savills over the last month, with the P/E ratio falling from 19.2 back then to 12.7 today. For those who prefer to invest with the flow of momentum, that might be a bad sign, but for a contrarian, it may signal opportunity.
When the market is wrong about a stock, it gives savvy investors an opportunity. 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 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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