To the annoyance of some shareholders, ZK International Group (NASDAQ:ZKIN) shares are down a considerable 32% in the last month. That drop has capped off a tough year for shareholders, with the share price down 60% in that time.
All else being equal, a share price drop should make a stock more attractive to potential investors. While the market sentiment towards a stock is very changeable, in the long run, the share price will tend to move in the same direction as earnings per share. 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 implies that investors have high expectations of what a company can achieve compared to a company with a low P/E ratio.
Does ZK International Group Have A Relatively High Or Low P/E For Its Industry?
We can tell from its P/E ratio of 2.70 that sentiment around ZK International Group isn't particularly high. If you look at the image below, you can see ZK International Group has a lower P/E than the average (12.9) in the metals and mining industry classification.
Its relatively low P/E ratio indicates that ZK International Group shareholders think it will struggle to do as well as other companies in its industry classification. Since the market seems unimpressed with ZK International Group, 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
Companies that shrink earnings per share quickly will rapidly decrease the 'E' in the equation. 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.
ZK International Group saw earnings per share decrease by 11% last year. And it has shrunk its earnings per share by 3.3% per year over the last five years. This could justify a pessimistic P/E.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. 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 ZK International Group's P/E?
ZK International Group has net debt worth 79% of its market capitalization. This is a reasonably significant level of debt -- all else being equal you'd expect a much lower P/E than if it had net cash.
The Bottom Line On ZK International Group's P/E Ratio
ZK International Group's P/E is 2.7 which is below average (17.5) in the US market. When you consider that the company has significant debt, and didn't grow EPS last year, it isn't surprising that the market has muted expectations. What can be absolutely certain is that the market has become more pessimistic about ZK International Group over the last month, with the P/E ratio falling from 3.9 back then to 2.7 today. For those who prefer invest in growth, this stock apparently offers limited promise, but the deep value investors may find the pessimism around this stock enticing.
Investors have an opportunity when market expectations about a stock are wrong. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. Although we don't have analyst forecasts shareholders might want to examine this detailed historical graph of earnings, revenue and cash flow.
Of course you might be able to find a better stock than ZK International Group. So you may wish to see this free collection of other companies that have grown earnings strongly.
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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. Thank you for reading.