To the annoyance of some shareholders, NagaCorp (HKG:3918) shares are down a considerable 35% in the last month. That drop has capped off a tough year for shareholders, with the share price down 33% 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. 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 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.
How Does NagaCorp's P/E Ratio Compare To Its Peers?
NagaCorp's P/E of 7.68 indicates relatively low sentiment towards the stock. The image below shows that NagaCorp has a lower P/E than the average (11.4) P/E for companies in the hospitality industry.
Its relatively low P/E ratio indicates that NagaCorp shareholders think it will struggle to do as well as other companies in its industry classification. Many investors like to buy stocks when the market is pessimistic about their prospects. You should delve deeper. I like to check if company insiders have been buying or selling.
How Growth Rates Impact P/E Ratios
Probably the most important factor in determining what P/E a company trades on is the earnings growth. Earnings growth means that in the future the 'E' will be higher. 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.
NagaCorp increased earnings per share by a whopping 33% last year. And earnings per share have improved by 15% annually, over the last five years. With that performance, I would expect it to have an above average P/E ratio.
Remember: P/E Ratios Don't Consider The Balance Sheet
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.
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.
So What Does NagaCorp's Balance Sheet Tell Us?
Since NagaCorp holds net cash of US$75m, it can spend on growth, justifying a higher P/E ratio than otherwise.
The Verdict On NagaCorp's P/E Ratio
NagaCorp's P/E is 7.7 which is below average (8.6) in the HK market. It grew its EPS nicely over the last year, and the healthy balance sheet implies there is more potential for growth. One might conclude that the market is a bit pessimistic, given the low P/E ratio. Given NagaCorp's P/E ratio has declined from 11.8 to 7.7 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 should be looking to buy stocks that the market is wrong about. 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.
You might be able to find a better buy than NagaCorp. 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).
If you spot an error that warrants correction, please contact the editor at email@example.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.