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A Sliding Share Price Has Us Looking At Schaffer Corporation Limited's (ASX:SFC) P/E Ratio

Simply Wall St

Unfortunately for some shareholders, the Schaffer (ASX:SFC) share price has dived 41% in the last thirty days. Even longer term holders have taken a real hit with the stock declining 28% in the last year.

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. One way to gauge market expectations of a stock 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.

Check out our latest analysis for Schaffer

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

Schaffer's P/E of 5.70 indicates relatively low sentiment towards the stock. The image below shows that Schaffer has a lower P/E than the average (10.5) P/E for companies in the auto components industry.

ASX:SFC Price Estimation Relative to Market March 26th 2020

Schaffer'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 Schaffer, it's quite possible it could surprise on the upside. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and selling.

How Growth Rates Impact P/E Ratios

P/E ratios primarily reflect market expectations around earnings growth rates. 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. Then, a lower P/E should attract more buyers, pushing the share price up.

Schaffer shrunk earnings per share by 1.5% last year. But over the longer term (5 years) earnings per share have increased by 49%.

Remember: P/E Ratios Don't Consider The Balance Sheet

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. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.

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.

Schaffer's Balance Sheet

Schaffer's net debt is 9.2% of its market cap. The market might award it a higher P/E ratio if it had net cash, but its unlikely this low level of net borrowing is having a big impact on the P/E multiple.

The Bottom Line On Schaffer's P/E Ratio

Schaffer has a P/E of 5.7. That's below the average in the AU market, which is 12.5. The debt levels are not a major concern, but the lack of EPS growth is likely weighing on sentiment. Given Schaffer's P/E ratio has declined from 9.7 to 5.7 in the last month, we know for sure that the market is more worried about the business today, than it was back then. 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 the reality for a company is not as bad as the P/E ratio indicates, then the share price should increase as the market realizes this. So this free report on the analyst consensus forecasts could help you make a master move on this stock.

But note: Schaffer 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 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.