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To the annoyance of some shareholders, Orrstown Financial Services (NASDAQ:ORRF) shares are down a considerable 34% in the last month. Indeed the recent decline has arguably caused some bitterness for shareholders who have held through the 36% 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). So, on certain occasions, long term focussed investors try to take advantage of pessimistic expectations to buy shares at a better price. 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 implies that investors have high expectations of what a company can achieve compared to a company with a low P/E ratio.
Does Orrstown Financial Services Have A Relatively High Or Low P/E For Its Industry?
Orrstown Financial Services's P/E of 7.51 indicates relatively low sentiment towards the stock. The image below shows that Orrstown Financial Services has a lower P/E than the average (8.6) P/E for companies in the banks industry.
This suggests that market participants think Orrstown Financial Services will underperform other companies in its industry. Many investors like to buy stocks when the market is pessimistic about their prospects. 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
Earnings growth rates have a big influence on P/E ratios. Earnings growth means that in the future the 'E' will be higher. That means unless the share price increases, the P/E will reduce in a few years. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
Orrstown Financial Services's earnings per share grew by 6.6% in the last twelve months. And earnings per share have improved by 26% annually, over the last three years. Unfortunately, earnings per share are down 15% a year, over 5 years.
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. That means it doesn't take debt or cash into account. Theoretically, a business can improve its earnings (and produce a lower P/E in the future) by investing in growth. That means taking on debt (or spending its cash).
Such spending might be good or bad, overall, but the key point here is that you need to look at debt to understand the P/E ratio in context.
Is Debt Impacting Orrstown Financial Services's P/E?
Orrstown Financial Services has net debt worth a very significant 148% of its market capitalization. This level of debt justifies a relatively low P/E, so remain cognizant of the debt, if you're comparing it to other stocks.
The Verdict On Orrstown Financial Services's P/E Ratio
Orrstown Financial Services has a P/E of 7.5. That's below the average in the US market, which is 12.5. It's good to see EPS growth in the last 12 months, but the debt on the balance sheet might be muting expectations. What can be absolutely certain is that the market has become more pessimistic about Orrstown Financial Services over the last month, with the P/E ratio falling from 11.4 back then to 7.5 today. For those who prefer to invest with the flow of momentum, that might be a bad sign, but for deep value investors this stock might justify some research.
Investors should be looking to buy stocks that the market is wrong about. If the reality for a company is not as bad as the P/E ratio indicates, then the share price should increase as the market realizes this. So this free report on the analyst consensus forecasts could help you make a master move on this stock.
You might be able to find a better buy than Orrstown Financial Services. 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 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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