A Sliding Share Price Has Us Looking At IGO Limited's (ASX:IGO) P/E Ratio
To the annoyance of some shareholders, IGO (ASX:IGO) shares are down a considerable 35% in the last month. The recent drop has obliterated the annual return, with the share price now down 23% over that longer period.
Assuming nothing else has changed, a lower share price makes a stock more attractive to potential buyers. 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. One way to gauge market expectations of a stock 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.
View our latest analysis for IGO
Does IGO Have A Relatively High Or Low P/E For Its Industry?
IGO's P/E of 12.74 indicates some degree of optimism towards the stock. The image below shows that IGO has a higher P/E than the average (8.2) P/E for companies in the metals and mining industry.
Its relatively high P/E ratio indicates that IGO shareholders think it will perform better than other companies in its industry classification. Shareholders are clearly optimistic, but the future is always uncertain. So further research is always essential. 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. Earnings growth means that in the future the 'E' will be higher. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. Then, a lower P/E should attract more buyers, pushing the share price up.
IGO's earnings made like a rocket, taking off 238% last year. And earnings per share have improved by 59% annually, over the last three years. So we'd absolutely expect it to have a relatively high P/E ratio. Regrettably, the longer term performance is poor, with EPS down 4.1% per year over 5 years.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. 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.
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 IGO's P/E?
With net cash of AU$465m, IGO has a very strong balance sheet, which may be important for its business. Having said that, at 19% of its market capitalization the cash hoard would contribute towards a higher P/E ratio.
The Bottom Line On IGO's P/E Ratio
IGO trades on a P/E ratio of 12.7, which is below the AU market average of 14.9. It grew its EPS nicely over the last year, and the healthy balance sheet implies there is more potential for growth. The below average P/E ratio suggests that market participants don't believe the strong growth will continue. Because analysts are predicting more growth in the future, one might have expected to see a higher P/E ratio. You can take a closer look at the fundamentals, here. Given IGO's P/E ratio has declined from 19.6 to 12.7 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 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. So this free report on the analyst consensus forecasts could help you make a master move on this stock.
Of course you might be able to find a better stock than IGO. So you may wish to see this free collection of other companies that have grown earnings strongly.
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.
