A Sliding Share Price Has Us Looking At Primero Group Limited's (ASX:PGX) P/E Ratio
To the annoyance of some shareholders, Primero Group (ASX:PGX) shares are down a considerable 33% in the last month. That drop has capped off a tough year for shareholders, with the share price down 38% 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). The implication here is that long term investors have an opportunity when expectations of a company are too low. 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.
Check out our latest analysis for Primero Group
Does Primero Group Have A Relatively High Or Low P/E For Its Industry?
We can tell from its P/E ratio of 7.22 that sentiment around Primero Group isn't particularly high. If you look at the image below, you can see Primero Group has a lower P/E than the average (15.4) in the construction industry classification.
Its relatively low P/E ratio indicates that Primero Group 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. 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
Earnings growth rates have a big influence on P/E ratios. That's because companies that grow earnings per share quickly will rapidly increase the 'E' in the equation. That means unless the share price increases, the P/E will reduce in a few years. And as that P/E ratio drops, the company will look cheap, unless its share price increases.
Primero Group shrunk earnings per share by 11% over the last year. But EPS is up 44% over the last 3 years.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
The 'Price' in P/E reflects the market capitalization of the company. 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.
Is Debt Impacting Primero Group's P/E?
Since Primero Group holds net cash of AU$159k, it can spend on growth, justifying a higher P/E ratio than otherwise.
The Verdict On Primero Group's P/E Ratio
Primero Group has a P/E of 7.2. That's below the average in the AU market, which is 18.6. The recent drop in earnings per share would almost certainly temper expectations, the relatively strong balance sheet will allow the company time to invest in growth. If it achieves that, then there's real potential that the low P/E could eventually indicate undervaluation. What can be absolutely certain is that the market has become more pessimistic about Primero Group over the last month, with the P/E ratio falling from 10.8 back then to 7.2 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. 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 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.
