Unfortunately for some shareholders, the Autoliv (NYSE:ALV) share price has dived 39% in the last thirty days. That drop has capped off a tough year for shareholders, with the share price down 40% in that time.
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 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.
Does Autoliv Have A Relatively High Or Low P/E For Its Industry?
Autoliv’s P/E of 8.95 indicates relatively low sentiment towards the stock. We can see in the image below that the average P/E (11.6) for companies in the auto components industry is higher than Autoliv’s P/E.
This suggests that market participants think Autoliv will underperform other companies in its industry. Since the market seems unimpressed with Autoliv, it’s quite possible it could surprise on the upside. You should delve deeper. I like to check if company insiders have been buying or selling.
How Growth Rates Impact P/E Ratios
When earnings fall, the ‘E’ decreases, over time. That means even if the current P/E is low, it will increase over time if the share price stays flat. Then, a higher P/E might scare off shareholders, pushing the share price down.
It’s great to see that Autoliv grew EPS by 23% in the last year. Unfortunately, earnings per share are down 5.8% a year, over 3 years.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. Thus, the metric does not reflect cash or debt held by the company. 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 Autoliv’s Debt Impact Its P/E Ratio?
Net debt is 40% of Autoliv’s market cap. While it’s worth keeping this in mind, it isn’t a worry.
The Bottom Line On Autoliv’s P/E Ratio
Autoliv has a P/E of 8.9. That’s below the average in the US market, which is 12.7. The EPS growth last year was strong, and debt levels are quite reasonable. The low P/E ratio suggests current market expectations are muted, implying these levels of growth will not continue. What can be absolutely certain is that the market has become more pessimistic about Autoliv over the last month, with the P/E ratio falling from 14.6 back then to 8.9 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 should be looking to buy stocks that the market is wrong about. If the reality for a company is not as bad as the P/E ratio indicates, then the share price should increase as the market realizes this. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.
You might be able to find a better buy than Autoliv. 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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