To the annoyance of some shareholders, Ocean Bio-Chem (NASDAQ:OBCI) shares are down a considerable in the last month. The recent drop has obliterated the annual return, with the share price now down 7.9% over that longer period.
All else being equal, a sharp share price increase should make a stock less 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 deep value investors might steer clear when expectations of a company are too high. 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 Ocean Bio-Chem’s P/E Ratio Compare To Its Peers?
We can tell from its P/E ratio of 11.61 that sentiment around Ocean Bio-Chem isn’t particularly high. The image below shows that Ocean Bio-Chem has a lower P/E than the average (26.8) P/E for companies in the household products industry.
Its relatively low P/E ratio indicates that Ocean Bio-Chem shareholders think it will struggle to do as well as other companies in its industry classification. Since the market seems unimpressed with Ocean Bio-Chem, 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
Probably the most important factor in determining what P/E a company trades on is the earnings growth. Earnings growth means that in the future the ‘E’ will be higher. 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.
Ocean Bio-Chem shrunk earnings per share by 16% over the last year. But over the longer term (5 years) earnings per share have increased by 6.6%.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
The ‘Price’ in P/E reflects the market capitalization of the company. So it won’t reflect the advantage of cash, or disadvantage of debt. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.
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 Ocean Bio-Chem’s Debt Impact Its P/E Ratio?
Net debt totals just 7.8% of Ocean Bio-Chem’s market cap. So it doesn’t have as many options as it would with net cash, but its debt would not have much of an impact on its P/E ratio.
The Verdict On Ocean Bio-Chem’s P/E Ratio
Ocean Bio-Chem has a P/E of 11.6. That’s below the average in the US market, which is 19.0. With only modest debt, it’s likely the lack of EPS growth at least partially explains the pessimism implied by the P/E ratio. What can be absolutely certain is that the market has become less optimistic about Ocean Bio-Chem over the last month, with the P/E ratio falling from 11.6 back then to 11.6 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 it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. Although we don’t have analyst forecasts you could get a better understanding of its growth by checking out this more detailed historical graph of earnings, revenue and cash flow.
You might be able to find a better buy than Ocean Bio-Chem. 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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