Unfortunately for some shareholders, the Daqo New Energy (NYSE:DQ) share price has dived 42% in the last thirty days. The stock has been solid, longer term, gaining 31% in the last year.
All else being equal, a share price drop should make a stock more attractive to potential investors. While the market sentiment towards a stock is very changeable, in the long run, the share price will tend to move in the same direction as earnings per share. 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.
Does Daqo New Energy Have A Relatively High Or Low P/E For Its Industry?
Daqo New Energy's P/E is 20.58. As you can see below Daqo New Energy has a P/E ratio that is fairly close for the average for the semiconductor industry, which is 22.0.
That indicates that the market expects Daqo New Energy 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. Further research into factors such as insider buying and selling, could help you form your own view on whether that is likely.
How Growth Rates Impact P/E Ratios
If earnings fall then in the future the 'E' will be lower. Therefore, even if you pay a low multiple of earnings now, that multiple will become higher in the future. A higher P/E should indicate the stock is expensive relative to others -- and that may encourage shareholders to sell.
Daqo New Energy shrunk earnings per share by 58% over the last year. And over the longer term (3 years) earnings per share have decreased 19% annually. This might lead to low expectations.
Remember: P/E Ratios Don't Consider The Balance Sheet
Don't forget that the P/E ratio considers market capitalization. So it won't reflect the advantage of cash, or disadvantage of debt. 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.
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 Daqo New Energy's Debt Impact Its P/E Ratio?
Daqo New Energy's net debt equates to 40% of its market capitalization. While that's enough to warrant consideration, it doesn't really concern us.
The Verdict On Daqo New Energy's P/E Ratio
Daqo New Energy's P/E is 20.6 which is above average (11.8) in its market. With modest debt but no EPS growth in the last year, it's fair to say the P/E implies some optimism about future earnings, from the market. What can be absolutely certain is that the market has become significantly less optimistic about Daqo New Energy over the last month, with the P/E ratio falling from 35.4 back then to 20.6 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.
When the market is wrong about a stock, it gives savvy investors an opportunity. 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 visual report on analyst forecasts could hold the key to an excellent investment decision.
But note: Daqo New Energy 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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