Unfortunately for some shareholders, the Gold Resource (NYSEMKT:GORO) share price has dived 45% in the last thirty days. Even longer term holders have taken a real hit with the stock declining 26% in the last year.
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 Gold Resource Have A Relatively High Or Low P/E For Its Industry?
We can tell from its P/E ratio of 31.78 that there is some investor optimism about Gold Resource. You can see in the image below that the average P/E (7.5) for companies in the metals and mining industry is a lot lower than Gold Resource's P/E.
Gold Resource's P/E tells us that market participants think the company will perform better than its industry peers, going forward. Clearly the market expects growth, but it isn't guaranteed. So further research is always essential. 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. And in that case, the P/E ratio itself will drop rather quickly. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
Gold Resource shrunk earnings per share by 43% over the last year. But it has grown its earnings per share by 4.8% per year over the last three years. And over the longer term (5 years) earnings per share have decreased 20% annually. This growth rate might warrant a below 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. In other words, it does not consider any debt or cash that the company may have on the balance sheet. In theory, a company can lower its future P/E ratio by using cash or debt to invest in 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).
Gold Resource's Balance Sheet
The extra options and safety that comes with Gold Resource's US$9.4m net cash position means that it deserves a higher P/E than it would if it had a lot of net debt.
The Verdict On Gold Resource's P/E Ratio
Gold Resource trades on a P/E ratio of 31.8, which is above its market average of 12.6. Falling earnings per share is probably keeping traditional value investors away, but the net cash position means the company has time to improve: and the high P/E suggests the market thinks it will. What can be absolutely certain is that the market has become significantly less optimistic about Gold Resource over the last month, with the P/E ratio falling from 57.8 back then to 31.8 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.
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 report on the analyst consensus forecasts could help you make a master move on this stock.
But note: Gold Resource 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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