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Unfortunately for some shareholders, the Ternium (NYSE:TX) share price has dived 49% in the last thirty days. Given the 62% drop over the last year, some shareholders might be worried that they have become bagholders. What is a bagholder? It is a shareholder who has suffered a bad loss, but continues to hold indefinitely, without questioning their reasons for holding, even as the losses grow greater.
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). 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 Ternium's P/E Ratio Compare To Its Peers?
Ternium's P/E of 3.58 indicates relatively low sentiment towards the stock. The image below shows that Ternium has a lower P/E than the average (6.9) P/E for companies in the metals and mining industry.
Its relatively low P/E ratio indicates that Ternium shareholders think it will struggle to do as well as other companies in its industry classification. Since the market seems unimpressed with Ternium, it's quite possible it could surprise on the upside. You should delve deeper. I like to check if company insiders have been buying or selling.
How Growth Rates Impact P/E Ratios
Companies that shrink earnings per share quickly will rapidly decrease the 'E' in the equation. That means even if the current P/E is low, it will increase over time if the share price stays flat. A higher P/E should indicate the stock is expensive relative to others -- and that may encourage shareholders to sell.
Ternium shrunk earnings per share by 63% over the last year. And over the longer term (3 years) earnings per share have decreased 1.8% annually. This could justify a low P/E.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
Don't forget that the P/E ratio considers market capitalization. Thus, the metric does not reflect cash or debt held by the company. Theoretically, a business can improve its earnings (and produce a lower P/E in the future) by investing in growth. That means taking on debt (or spending its cash).
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.
How Does Ternium's Debt Impact Its P/E Ratio?
Ternium's net debt is 65% of its market cap. This is a reasonably significant level of debt -- all else being equal you'd expect a much lower P/E than if it had net cash.
The Verdict On Ternium's P/E Ratio
Ternium trades on a P/E ratio of 3.6, which is below the US market average of 11.5. The P/E reflects market pessimism that probably arises from the lack of recent EPS growth, paired with significant leverage. What can be absolutely certain is that the market has become more pessimistic about Ternium over the last month, with the P/E ratio falling from 7.1 back then to 3.6 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.
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 report on the analyst consensus forecasts could help you make a master move on this stock.
Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.
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.
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