Unfortunately for some shareholders, the Broadcom (NASDAQ:AVGO) share price has dived 41% in the last thirty days. Indeed the recent decline has arguably caused some bitterness for shareholders who have held through the 37% drop over twelve months.
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. 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 implies that investors have high expectations of what a company can achieve compared to a company with a low P/E ratio.
Does Broadcom Have A Relatively High Or Low P/E For Its Industry?
We can tell from its P/E ratio of 29.43 that there is some investor optimism about Broadcom. You can see in the image below that the average P/E (22.9) for companies in the semiconductor industry is lower than Broadcom’s P/E.
Broadcom’s P/E tells us that market participants think the company will perform better than its industry peers, going forward. Shareholders are clearly optimistic, but the future is always uncertain. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.
How Growth Rates Impact P/E Ratios
Generally speaking the rate of earnings growth has a profound impact on a company’s P/E multiple. If earnings are growing quickly, then the ‘E’ in the equation will increase faster than it would otherwise. That means unless the share price increases, the P/E will reduce in a few years. A lower P/E should indicate the stock is cheap relative to others — and that may attract buyers.
Broadcom shrunk earnings per share by 60% over the last year. But EPS is up 26% over the last 5 years.
Remember: P/E Ratios Don’t Consider The Balance Sheet
It’s important to note that the P/E ratio considers the market capitalization, not the enterprise value. That means it doesn’t take debt or cash into account. 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.
How Does Broadcom’s Debt Impact Its P/E Ratio?
Broadcom’s net debt is 51% of its market cap. If you want to compare its P/E ratio to other companies, you should absolutely keep in mind it has significant borrowings.
The Verdict On Broadcom’s P/E Ratio
Broadcom has a P/E of 29.4. That’s higher than the average in its market, which is 12.7. With meaningful debt and a lack of recent earnings growth, the market has high expectations that the business will earn more in the future. What can be absolutely certain is that the market has become significantly less optimistic about Broadcom over the last month, with the P/E ratio falling from 49.9 back then to 29.4 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.
When the market is wrong about a stock, it gives savvy investors an opportunity. People often underestimate remarkable growth — so investors can make money when fast growth is not fully appreciated. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.
But note: Broadcom 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 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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