Unfortunately for some shareholders, the Guaranty Federal Bancshares (NASDAQ:GFED) share price has dived 38% 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). Investors have optimistic expectations of companies with higher P/E ratios, compared to companies with lower P/E ratios.
Does Guaranty Federal Bancshares Have A Relatively High Or Low P/E For Its Industry?
Guaranty Federal Bancshares's P/E of 7.00 indicates relatively low sentiment towards the stock. We can see in the image below that the average P/E (10.4) for companies in the mortgage industry is higher than Guaranty Federal Bancshares's P/E.
Its relatively low P/E ratio indicates that Guaranty Federal Bancshares shareholders think it will struggle to do as well as other companies in its industry classification. Many investors like to buy stocks when the market is pessimistic about their prospects. 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. Earnings growth means that in the future the 'E' will be higher. And in that case, the P/E ratio itself will drop rather quickly. And as that P/E ratio drops, the company will look cheap, unless its share price increases.
Guaranty Federal Bancshares increased earnings per share by a whopping 29% last year. And its annual EPS growth rate over 5 years is 9.6%. With that performance, I would expect it to have an above average P/E ratio.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
Don't forget that the P/E ratio considers market capitalization. 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 Guaranty Federal Bancshares's Debt Impact Its P/E Ratio?
Guaranty Federal Bancshares has net debt worth just 3.5% of its market capitalization. So it doesn't have as many options as it would with net cash, but its debt would not have much of an impact on its P/E ratio.
The Verdict On Guaranty Federal Bancshares's P/E Ratio
Guaranty Federal Bancshares trades on a P/E ratio of 7.0, which is below the US market average of 12.6. 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. Since analysts are predicting growth will continue, one might expect to see a higher P/E so it may be worth looking closer. Given Guaranty Federal Bancshares's P/E ratio has declined from 11.2 to 7.0 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 visual report on analyst forecasts could hold the key to an excellent investment decision.
Of course you might be able to find a better stock than Guaranty Federal Bancshares. 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 firstname.lastname@example.org. 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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