Unfortunately for some shareholders, the Mahanagar Gas (NSE:MGL) share price has dived 34% in the last thirty days. The recent drop has obliterated the annual return, with the share price now down 23% over that longer period.
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. 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 Mahanagar Gas’s P/E Ratio Compare To Its Peers?
We can tell from its P/E ratio of 9.72 that sentiment around Mahanagar Gas isn’t particularly high. We can see in the image below that the average P/E (13.8) for companies in the gas utilities industry is higher than Mahanagar Gas’s P/E.
Its relatively low P/E ratio indicates that Mahanagar Gas shareholders think it will struggle to do as well as other companies in its industry classification. Since the market seems unimpressed with Mahanagar Gas, it’s quite possible it could surprise on the upside. 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
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.
Notably, Mahanagar Gas grew EPS by a whopping 47% in the last year. And its annual EPS growth rate over 5 years is 18%. So we’d generally expect it to have a relatively high P/E ratio.
Don’t Forget: The P/E Does Not Account For Debt or Bank Deposits
It’s important to note that the P/E ratio considers the market capitalization, not the enterprise value. In other words, it does not consider any debt or cash that the company may have on the balance sheet. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.
Such spending might be good or bad, overall, but the key point here is that you need to look at debt to understand the P/E ratio in context.
Is Debt Impacting Mahanagar Gas’s P/E?
With net cash of ₹13b, Mahanagar Gas has a very strong balance sheet, which may be important for its business. Having said that, at 15% of its market capitalization the cash hoard would contribute towards a higher P/E ratio.
The Verdict On Mahanagar Gas’s P/E Ratio
Mahanagar Gas has a P/E of 9.7. That’s around the same as the average in the IN market, which is 10.3. Its net cash position is the cherry on top of its superb EPS growth. So based on this analysis we’d expect Mahanagar Gas to have a higher P/E ratio. What can be absolutely certain is that the market has become more pessimistic about Mahanagar Gas over the last month, with the P/E ratio falling from 14.8 back then to 9.7 today. 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. 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. Although we don’t have analyst forecasts you might want to assess this data-rich visualization of earnings, revenue and cash flow.
Of course you might be able to find a better stock than Mahanagar Gas. 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 firstname.lastname@example.org. 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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