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To the annoyance of some shareholders, Kaiser Aluminum (NASDAQ:KALU) shares are down a considerable 48% in the last month. Indeed the recent decline has arguably caused some bitterness for shareholders who have held through the 46% 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 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 Kaiser Aluminum Have A Relatively High Or Low P/E For Its Industry?
We can tell from its P/E ratio of 14.31 that there is some investor optimism about Kaiser Aluminum. The image below shows that Kaiser Aluminum has a higher P/E than the average (7.4) P/E for companies in the metals and mining industry.
That means that the market expects Kaiser Aluminum will outperform other companies in its industry. The market is optimistic about the future, but that doesn't guarantee future growth. So investors should delve deeper. I like to check if company insiders have been buying or selling.
How Growth Rates Impact P/E Ratios
If earnings fall then in the future the 'E' will be lower. That means unless the share price falls, the P/E will increase in a few years. A higher P/E should indicate the stock is expensive relative to others -- and that may encourage shareholders to sell.
Kaiser Aluminum's earnings per share fell by 30% in the last twelve months. And over the longer term (3 years) earnings per share have decreased 9.0% annually. This growth rate might warrant a low P/E ratio.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
The 'Price' in P/E reflects the market capitalization of the company. In other words, it does not consider any debt or cash that the company may have on the balance sheet. 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.
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).
So What Does Kaiser Aluminum's Balance Sheet Tell Us?
Kaiser Aluminum has net debt worth 17% of its market capitalization. It would probably deserve a higher P/E ratio if it was net cash, since it would have more options for growth.
The Verdict On Kaiser Aluminum's P/E Ratio
Kaiser Aluminum has a P/E of 14.3. That's higher than the average in its market, which is 11.8. 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. Given Kaiser Aluminum's P/E ratio has declined from 27.7 to 14.3 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. 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 report on the analyst consensus forecasts could help you make a master move on this stock.
Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.
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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