U.S. markets closed

A Sliding Share Price Has Us Looking At Mineral Commodities Ltd's (ASX:MRC) P/E Ratio

Simply Wall St

Unfortunately for some shareholders, the Mineral Commodities (ASX:MRC) share price has dived 32% in the last thirty days. Indeed, the recent drop has reduced the annual gain to a relatively sedate 5.6% over the last twelve months.

All else being equal, a share price drop should make a stock more attractive to potential investors. 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). Investors have optimistic expectations of companies with higher P/E ratios, compared to companies with lower P/E ratios.

Check out our latest analysis for Mineral Commodities

Does Mineral Commodities Have A Relatively High Or Low P/E For Its Industry?

We can tell from its P/E ratio of 6.78 that sentiment around Mineral Commodities isn't particularly high. We can see in the image below that the average P/E (11.4) for companies in the metals and mining industry is higher than Mineral Commodities's P/E.

ASX:MRC Price Estimation Relative to Market, March 9th 2020

This suggests that market participants think Mineral Commodities 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

Probably the most important factor in determining what P/E a company trades on is the earnings growth. 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.

Mineral Commodities saw earnings per share decrease by 12% last year. But EPS is up 26% over the last 3 years. And EPS is down 2.1% a year, over the last 5 years. This growth rate might warrant a below 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. 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.

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.

Mineral Commodities's Balance Sheet

The extra options and safety that comes with Mineral Commodities's US$3.6m net cash position means that it deserves a higher P/E than it would if it had a lot of net debt.

The Verdict On Mineral Commodities's P/E Ratio

Mineral Commodities has a P/E of 6.8. That's below the average in the AU market, which is 17.0. Falling earnings per share are likely to be keeping potential buyers away, but the net cash position means the company has time to improve: if so, the low P/E could be an opportunity. Given Mineral Commodities's P/E ratio has declined from 10.0 to 6.8 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 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. We don't have analyst forecasts, but shareholders might want to examine this detailed historical graph of earnings, revenue and cash flow.

But note: Mineral Commodities may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).

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.