To the annoyance of some shareholders, OZ Minerals (ASX:OZL) shares are down a considerable 31% in the last month. That drop has capped off a tough year for shareholders, with the share price down 30% in that time.
All else being equal, a share price drop should make a stock more attractive to potential investors. 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). Investors have optimistic expectations of companies with higher P/E ratios, compared to companies with lower P/E ratios.
How Does OZ Minerals’s P/E Ratio Compare To Its Peers?
OZ Minerals’s P/E of 13.81 indicates some degree of optimism towards the stock. The image below shows that OZ Minerals has a higher P/E than the average (8.2) P/E for companies in the metals and mining industry.
That means that the market expects OZ Minerals will outperform other companies in its industry. Clearly the market expects growth, but it isn’t guaranteed. 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
P/E ratios primarily reflect market expectations around earnings growth rates. 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. Then, a lower P/E should attract more buyers, pushing the share price up.
OZ Minerals’s earnings per share fell by 29% in the last twelve months. But it has grown its earnings per share by 30% per year over the last five years.
Remember: P/E Ratios Don’t Consider The Balance Sheet
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. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
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 OZ Minerals’s Balance Sheet Tell Us?
The extra options and safety that comes with OZ Minerals’s AU$134m net cash position means that it deserves a higher P/E than it would if it had a lot of net debt.
The Verdict On OZ Minerals’s P/E Ratio
OZ Minerals’s P/E is 13.8 which is about average (14.9) in the AU market. Although the recent drop in earnings per share would keep the market cautious, the healthy balance sheet means the company retains potential for future growth. So it’s not surprising to see it trade on a P/E roughly in line with the market. What can be absolutely certain is that the market has become significantly less optimistic about OZ Minerals over the last month, with the P/E ratio falling from 20.0 back then to 13.8 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. 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.
You might be able to find a better buy than OZ Minerals. 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 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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