To the annoyance of some shareholders, Gage Roads Brewing (ASX:GRB) shares are down a considerable 34% in the last month. That drop has capped off a tough year for shareholders, with the share price down 57% in that time.
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.
Does Gage Roads Brewing Have A Relatively High Or Low P/E For Its Industry?
We can tell from its P/E ratio of 49.50 that there is some investor optimism about Gage Roads Brewing. As you can see below, Gage Roads Brewing has a higher P/E than the average company (17.5) in the beverage industry.
Its relatively high P/E ratio indicates that Gage Roads Brewing shareholders think it will perform better than other companies in its industry classification. Clearly the market expects growth, but it isn't guaranteed. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.
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. So while a stock may look cheap based on past earnings, it could be expensive based on future earnings.
Gage Roads Brewing shrunk earnings per share by 66% over the last year. And it has shrunk its earnings per share by 28% per year over the last three years. This might lead to low expectations.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
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. 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.
While growth expenditure doesn't always pay off, the point is that it is a good option to have; but one that the P/E ratio ignores.
Gage Roads Brewing's Balance Sheet
Gage Roads Brewing's net debt is 0.6% 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 Verdict On Gage Roads Brewing's P/E Ratio
Gage Roads Brewing has a P/E of 49.5. That's significantly higher than the average in its market, which is 13.9. With some debt but no EPS growth last year, the market has high expectations of future profits. Given Gage Roads Brewing's P/E ratio has declined from 74.8 to 49.5 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. People often underestimate remarkable growth -- so investors can make money when fast growth is not fully appreciated. 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 Gage Roads Brewing. 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 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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