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A Sliding Share Price Has Us Looking At Infigen Energy Limited's (ASX:IFN) P/E Ratio

Simply Wall St

To the annoyance of some shareholders, Infigen Energy (ASX:IFN) shares are down a considerable 34% in the last month. The recent drop has obliterated the annual return, with the share price now down 3.4% over that longer period.

Assuming nothing else has changed, a lower share price makes a stock more attractive to potential buyers. In the long term, share prices tend to follow earnings per share, but in the short term prices bounce around in response to short term factors (which are not always obvious). 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 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.

Check out our latest analysis for Infigen Energy

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

Infigen Energy's P/E of 8.85 indicates relatively low sentiment towards the stock. We can see in the image below that the average P/E (16.3) for companies in the renewable energy industry is higher than Infigen Energy's P/E.

ASX:IFN Price Estimation Relative to Market March 31st 2020
ASX:IFN Price Estimation Relative to Market March 31st 2020

This suggests that market participants think Infigen Energy will underperform other companies in its industry. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. 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. That's because companies that grow earnings per share quickly will rapidly increase the 'E' in the equation. And in that case, the P/E ratio itself will drop rather quickly. And as that P/E ratio drops, the company will look cheap, unless its share price increases.

Infigen Energy increased earnings per share by an impressive 15% over the last twelve months. And it has improved its earnings per share by 6.3% per year over the last three years. This could arguably justify a relatively high P/E ratio.

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

Don't forget that the P/E ratio considers market capitalization. So it won't reflect the advantage of cash, or disadvantage of debt. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.

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).

So What Does Infigen Energy's Balance Sheet Tell Us?

Net debt totals a substantial 120% of Infigen Energy's market cap. This level of debt justifies a relatively low P/E, so remain cognizant of the debt, if you're comparing it to other stocks.

The Bottom Line On Infigen Energy's P/E Ratio

Infigen Energy has a P/E of 8.9. That's below the average in the AU market, which is 12.9. The company has a meaningful amount of debt on the balance sheet, but that should not eclipse the solid earnings growth. If it continues to grow, then the current low P/E may prove to be unjustified. Given Infigen Energy's P/E ratio has declined from 13.3 to 8.9 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 to invest with the flow of momentum, that might be a bad sign, but for deep value investors this stock might justify some research.

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 visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.

Of course you might be able to find a better stock than Infigen Energy. 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.