To the annoyance of some shareholders, Modine Manufacturing (NYSE:MOD) shares are down a considerable 36% in the last month. Indeed the recent decline has arguably caused some bitterness for shareholders who have held through the 45% 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). So, on certain occasions, long term focussed investors try to take advantage of pessimistic expectations to buy shares at a better price. One way to gauge market expectations of a stock 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.
How Does Modine Manufacturing's P/E Ratio Compare To Its Peers?
We can tell from its P/E ratio of 13.71 that sentiment around Modine Manufacturing isn't particularly high. We can see in the image below that the average P/E (16.8) for companies in the auto components industry is higher than Modine Manufacturing's P/E.
This suggests that market participants think Modine Manufacturing will underperform other companies in its industry. Since the market seems unimpressed with Modine Manufacturing, it's quite possible it could surprise on the upside. 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
Earnings growth rates have a big influence on P/E ratios. That's because companies that grow earnings per share quickly will rapidly increase the 'E' in the equation. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. Then, a lower P/E should attract more buyers, pushing the share price up.
Modine Manufacturing's earnings per share fell by 45% in the last twelve months. But EPS is up 8.0% over the last 3 years. And over the longer term (5 years) earnings per share have decreased 28% annually. This growth rate might warrant a below average P/E ratio.
Remember: P/E Ratios Don't Consider The Balance Sheet
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. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
Such expenditure might be good or bad, in the long term, but the point here is that the balance sheet is not reflected by this ratio.
Modine Manufacturing's Balance Sheet
Modine Manufacturing's net debt is considerable, at 114% of its 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 Modine Manufacturing's P/E Ratio
Modine Manufacturing has a P/E of 13.7. That's below the average in the US market, which is 18.1. The P/E reflects market pessimism that probably arises from the lack of recent EPS growth, paired with significant leverage. Given Modine Manufacturing's P/E ratio has declined from 21.3 to 13.7 in the last month, we know for sure that the market is significantly less confident 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 a contrarian, it may signal opportunity.
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 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 Modine Manufacturing. 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.
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.