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A Sliding Share Price Has Us Looking At Sodexo S.A.'s (EPA:SW) P/E Ratio

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Unfortunately for some shareholders, the Sodexo (EPA:SW) share price has dived 36% in the last thirty days. Indeed the recent decline has arguably caused some bitterness for shareholders who have held through the 36% 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). Investors have optimistic expectations of companies with higher P/E ratios, compared to companies with lower P/E ratios.

View our latest analysis for Sodexo

How Does Sodexo's P/E Ratio Compare To Its Peers?

Sodexo's P/E of 13.74 indicates relatively low sentiment towards the stock. The image below shows that Sodexo has a lower P/E than the average (18.4) P/E for companies in the hospitality industry.

ENXTPA:SW Price Estimation Relative to Market, March 13th 2020
ENXTPA:SW Price Estimation Relative to Market, March 13th 2020

Sodexo's P/E tells us that market participants think it will not fare as well as its peers in the same industry. Since the market seems unimpressed with Sodexo, 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. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. That means even if the current P/E is high, it will reduce over time if the share price stays flat. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.

Sodexo saw earnings per share improve by -3.8% last year. And its annual EPS growth rate over 5 years is 7.2%.

A Limitation: P/E Ratios Ignore Debt and Cash In The Bank

It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. 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.

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.

So What Does Sodexo's Balance Sheet Tell Us?

Sodexo has net debt equal to 26% of its market cap. While it's worth keeping this in mind, it isn't a worry.

The Bottom Line On Sodexo's P/E Ratio

Sodexo trades on a P/E ratio of 13.7, which is fairly close to the FR market average of 14.2. With modest debt and some recent earnings growth, it seems likely the market expects a steady performance going forward. Given Sodexo's P/E ratio has declined from 21.6 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 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. 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 Sodexo. 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 editorial-team@simplywallst.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.