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A Sliding Share Price Has Us Looking At American Vanguard Corporation's (NYSE:AVD) P/E Ratio

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Unfortunately for some shareholders, the American Vanguard (NYSE:AVD) share price has dived 35% in the last thirty days. Indeed the recent decline has arguably caused some bitterness for shareholders who have held through the 34% drop over twelve months.

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). 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.

View our latest analysis for American Vanguard

Does American Vanguard Have A Relatively High Or Low P/E For Its Industry?

We can tell from its P/E ratio of 25.38 that there is some investor optimism about American Vanguard. You can see in the image below that the average P/E (14.9) for companies in the chemicals industry is lower than American Vanguard's P/E.

NYSE:AVD Price Estimation Relative to Market, March 17th 2020
NYSE:AVD Price Estimation Relative to Market, March 17th 2020

That means that the market expects American Vanguard will outperform other companies in its industry. Shareholders are clearly optimistic, but the future is always uncertain. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.

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. Earnings growth means that in the future the 'E' will be higher. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. And as that P/E ratio drops, the company will look cheap, unless its share price increases.

American Vanguard saw earnings per share decrease by 43% last year. But over the longer term (5 years) earnings per share have increased by 22%.

Don't Forget: The P/E Does Not Account For Debt or Bank Deposits

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. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.

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).

American Vanguard's Balance Sheet

American Vanguard has net debt equal to 40% of its market cap. You'd want to be aware of this fact, but it doesn't bother us.

The Verdict On American Vanguard's P/E Ratio

American Vanguard has a P/E of 25.4. That's higher than the average in its market, which is 12.7. With a bit of debt, but a lack of recent growth, it's safe to say the market is expecting improved profit performance from the company, in the next few years. What can be absolutely certain is that the market has become significantly less optimistic about American Vanguard over the last month, with the P/E ratio falling from 39.0 back then to 25.4 today. For those who don't like to trade against momentum, that could be a warning sign, but a contrarian investor might want to take a closer look.

Investors should be looking to buy stocks that the market is wrong about. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. So this free report on the analyst consensus forecasts could help you make a master move on this stock.

Of course you might be able to find a better stock than American Vanguard. 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.