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To the annoyance of some shareholders, Barnes Group (NYSE:B) shares are down a considerable 49% in the last month. Indeed the recent decline has arguably caused some bitterness for shareholders who have held through the 39% drop over twelve months.
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 ratio means that investors have a high expectation about future growth, while a low P/E ratio means they have low expectations about future growth.
Does Barnes Group Have A Relatively High Or Low P/E For Its Industry?
We can tell from its P/E ratio of 10.76 that sentiment around Barnes Group isn't particularly high. The image below shows that Barnes Group has a lower P/E than the average (13.7) P/E for companies in the machinery industry.
This suggests that market participants think Barnes Group will underperform other companies in its industry. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and selling.
How Growth Rates Impact P/E Ratios
Probably the most important factor in determining what P/E a company trades on is the earnings growth. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.
Barnes Group saw earnings per share decrease by 2.7% last year. But EPS is up 7.0% over the last 5 years.
Remember: P/E Ratios Don't Consider The Balance Sheet
Don't forget that the P/E ratio considers market capitalization. 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.
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.
So What Does Barnes Group's Balance Sheet Tell Us?
Barnes Group's net debt equates to 43% of its market capitalization. While it's worth keeping this in mind, it isn't a worry.
The Bottom Line On Barnes Group's P/E Ratio
Barnes Group trades on a P/E ratio of 10.8, which is below the US market average of 11.8. The debt levels are not a major concern, but the lack of EPS growth is likely weighing on sentiment. What can be absolutely certain is that the market has become significantly less optimistic about Barnes Group over the last month, with the P/E ratio falling from 21.0 back then to 10.8 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.
Investors have an opportunity when market expectations about a stock are wrong. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. So this free visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.
You might be able to find a better buy than Barnes Group. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
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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