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To the annoyance of some shareholders, Wi2Wi (CVE:YTY) shares are down a considerable 44% in the last month. That drop has capped off a tough year for shareholders, with the share price down 44% in that time.
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). So, on certain occasions, long term focussed investors try to take advantage of pessimistic expectations to buy shares at a better price. 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.
How Does Wi2Wi's P/E Ratio Compare To Its Peers?
Wi2Wi's P/E of 10.63 indicates relatively low sentiment towards the stock. We can see in the image below that the average P/E (24.6) for companies in the communications industry is higher than Wi2Wi's P/E.
Its relatively low P/E ratio indicates that Wi2Wi 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. 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
When earnings fall, the 'E' decreases, over time. That means even if the current P/E is low, it will increase over time if the share price stays flat. Then, a higher P/E might scare off shareholders, pushing the share price down.
In the last year, Wi2Wi grew EPS like Taylor Swift grew her fan base back in 2010; the 228% gain was both fast and well deserved. Unfortunately, earnings per share are down 14% a year, over 3 years.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. 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.
Wi2Wi's Balance Sheet
With net cash of US$1.9m, Wi2Wi has a very strong balance sheet, which may be important for its business. Having said that, at 40% of its market capitalization the cash hoard would contribute towards a higher P/E ratio.
The Bottom Line On Wi2Wi's P/E Ratio
Wi2Wi has a P/E of 10.6. That's higher than the average in its market, which is 9.7. The excess cash it carries is the gravy on top its fast EPS growth. To us, this is the sort of company that we would expect to carry an above average price tag (relative to earnings). What can be absolutely certain is that the market has become significantly less optimistic about Wi2Wi over the last month, with the P/E ratio falling from 18.9 back then to 10.6 today. For those who don't like to trade against momentum, that could be a warning sign, but a contrarian investor might want to take a closer look.
Investors have an opportunity when market expectations about a stock are wrong. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. 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 Wi2Wi. 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 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.