To the annoyance of some shareholders, MJ Gleeson (LON:GLE) shares are down a considerable 37% in the last month. 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). The implication here is that long term investors have an opportunity when expectations of a company are too low. 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 MJ Gleeson’s P/E Ratio Compare To Its Peers?
We can tell from its P/E ratio of 12.77 that there is some investor optimism about MJ Gleeson. As you can see below, MJ Gleeson has a higher P/E than the average company (8.4) in the consumer durables industry.
Its relatively high P/E ratio indicates that MJ Gleeson shareholders think it will perform better than other companies in its industry classification. Clearly the market expects growth, but it isn’t guaranteed. So investors should delve deeper. I like to check if company insiders have been buying or selling.
How Growth Rates Impact P/E Ratios
P/E ratios primarily reflect market expectations around earnings growth rates. When earnings grow, the ‘E’ increases, over time. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. And as that P/E ratio drops, the company will look cheap, unless its share price increases.
MJ Gleeson saw earnings per share decrease by 30% last year. But it has grown its earnings per share by 8.1% per year over the last five years.
Don’t Forget: The P/E Does Not Account For Debt or Bank Deposits
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. 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.
While growth expenditure doesn’t always pay off, the point is that it is a good option to have; but one that the P/E ratio ignores.
So What Does MJ Gleeson’s Balance Sheet Tell Us?
Since MJ Gleeson holds net cash of UK£31m, it can spend on growth, justifying a higher P/E ratio than otherwise.
The Bottom Line On MJ Gleeson’s P/E Ratio
MJ Gleeson trades on a P/E ratio of 12.8, which is fairly close to the GB market average of 12.5. While the lack of recent growth is probably muting optimism, the relatively strong balance sheet will allow the company to weather a storm; so it isn’t very surprising to see that it has a P/E ratio close to the market average. What can be absolutely certain is that the market has become significantly less optimistic about MJ Gleeson over the last month, with the P/E ratio falling from 20.4 back then to 12.8 today. For those who prefer to invest with the flow of momentum, that might be a bad sign, but for a contrarian, it may signal opportunity.
Investors should be looking to buy stocks that the market is wrong about. 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.
You might be able to find a better buy than MJ Gleeson. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
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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