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A Sliding Share Price Has Us Looking At ARC Document Solutions, Inc.'s (NYSE:ARC) P/E Ratio

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Simply Wall St
·4 min read
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Unfortunately for some shareholders, the ARC Document Solutions (NYSE:ARC) share price has dived 59% in the last thirty days. And that drop will have no doubt have some shareholders concerned that the 77% share price decline, over the last year, has turned them into bagholders. For those wondering, a bagholder is someone who keeps holding a losing stock indefinitely, without taking the time to consider its prospects carefully, going forward.

Assuming nothing else has changed, a lower share price makes a stock more 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). So, on certain occasions, long term focussed investors try to take advantage of pessimistic expectations to buy shares at a better price. 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.

Check out our latest analysis for ARC Document Solutions

How Does ARC Document Solutions's P/E Ratio Compare To Its Peers?

ARC Document Solutions's P/E of 7.76 indicates relatively low sentiment towards the stock. We can see in the image below that the average P/E (20.2) for companies in the commercial services industry is higher than ARC Document Solutions's P/E.

NYSE:ARC Price Estimation Relative to Market, March 20th 2020
NYSE:ARC Price Estimation Relative to Market, March 20th 2020

This suggests that market participants think ARC Document Solutions will underperform other companies in its 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. When earnings grow, the 'E' increases, over time. That means unless the share price increases, the P/E will reduce in a few years. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.

ARC Document Solutions shrunk earnings per share by 66% over the last year. And over the longer term (5 years) earnings per share have decreased 16% annually. This growth rate might warrant a below average 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. 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.

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.

Is Debt Impacting ARC Document Solutions's P/E?

Net debt totals a substantial 130% of ARC Document Solutions's market cap. This is a relatively high level of debt, so the stock probably deserves a relatively low P/E ratio. Keep that in mind when comparing it to other companies.

The Bottom Line On ARC Document Solutions's P/E Ratio

ARC Document Solutions's P/E is 7.8 which is below average (12.2) in the US market. The P/E reflects market pessimism that probably arises from the lack of recent EPS growth, paired with significant leverage. Given ARC Document Solutions's P/E ratio has declined from 19.0 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 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 have an opportunity when market expectations about a stock are wrong. 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. Although we don't have analyst forecasts you could get a better understanding of its growth by checking out this more detailed historical graph of earnings, revenue and cash flow.

Of course you might be able to find a better stock than ARC Document Solutions. 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.