Unfortunately for some shareholders, the RMR Group (NASDAQ:RMR) share price has dived 32% in the last thirty days. Indeed the recent decline has arguably caused some bitterness for shareholders who have held through the 57% drop over twelve months.
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. 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 RMR Group Have A Relatively High Or Low P/E For Its Industry?
We can tell from its P/E ratio of 13.66 that sentiment around RMR Group isn't particularly high. The image below shows that RMR Group has a lower P/E than the average (15.6) P/E for companies in the real estate industry.
Its relatively low P/E ratio indicates that RMR Group shareholders think it will struggle to do as well as other companies in its industry classification. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. You 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 even if the current P/E is low, it will increase over time if the share price stays flat. So while a stock may look cheap based on past earnings, it could be expensive based on future earnings.
RMR Group's earnings per share fell by 59% in the last twelve months. And it has shrunk its earnings per share by 10% per year over the last three years. This might lead to low expectations.
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. 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).
How Does RMR Group's Debt Impact Its P/E Ratio?
RMR Group has net cash of US$386m. This is fairly high at 46% of its market capitalization. That might mean balance sheet strength is important to the business, but should also help push the P/E a bit higher than it would otherwise be.
The Bottom Line On RMR Group's P/E Ratio
RMR Group has a P/E of 13.7. That's around the same as the average in the US market, which is 13.1. While the lack of recent growth is probably muting optimism, the net cash position means it's not surprising that expectations put the company roughly in line with the market average P/E. Given RMR Group's P/E ratio has declined from 20.0 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 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. People often underestimate remarkable growth -- so investors can make money when fast growth is not fully appreciated. 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.
But note: RMR Group 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 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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