To the annoyance of some shareholders, International Cement Group (SGX:KUO) shares are down a considerable 47% in the last month. Zooming out, the recent drop wiped out a year's worth of gains, with the share price now back where it was a year ago.
All else being equal, a share price drop should make a stock more attractive to potential investors. 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. One way to gauge market expectations of a stock is to look at its Price to Earnings Ratio (PE Ratio). Investors have optimistic expectations of companies with higher P/E ratios, compared to companies with lower P/E ratios.
Does International Cement Group Have A Relatively High Or Low P/E For Its Industry?
International Cement Group's P/E of 6.74 indicates relatively low sentiment towards the stock. The image below shows that International Cement Group has a lower P/E than the average (13.2) P/E for companies in the basic materials industry.
Its relatively low P/E ratio indicates that International Cement Group shareholders think it will struggle to do as well as other companies in its industry classification. Since the market seems unimpressed with International Cement Group, it's quite possible it could surprise on the upside. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.
How Growth Rates Impact P/E Ratios
P/E ratios primarily reflect market expectations around earnings growth rates. When earnings grow, the 'E' increases, over time. 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.
It's nice to see that International Cement Group grew EPS by a stonking 47% in the last year. And its annual EPS growth rate over 5 years is 39%. With that performance, I would expect it to have an above average P/E ratio.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
Don't forget that the P/E ratio considers market capitalization. In other words, it does not consider any debt or cash that the company may have on the balance sheet. 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).
International Cement Group's Balance Sheet
International Cement Group's net debt is 5.0% of its market cap. It would probably trade on a higher P/E ratio if it had a lot of cash, but I doubt it is having a big impact.
The Bottom Line On International Cement Group's P/E Ratio
International Cement Group trades on a P/E ratio of 6.7, which is below the SG market average of 13.5. The company hasn't stretched its balance sheet, and earnings growth was good last year. If the company can continue to grow earnings, then the current P/E may be unjustifiably low. What can be absolutely certain is that the market has become more pessimistic about International Cement Group over the last month, with the P/E ratio falling from 12.8 back then to 6.7 today. 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.
When the market is wrong about a stock, it gives savvy investors an opportunity. As value investor Benjamin Graham famously said, 'In the short run, the market is a voting machine but in the long run, it is a weighing machine. We don't have analyst forecasts, but shareholders might want to examine this detailed historical graph of earnings, revenue and cash flow.
You might be able to find a better buy than International Cement Group. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
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