To the annoyance of some shareholders, Champion Iron (ASX:CIA) shares are down a considerable 34% in the last month. The recent drop has obliterated the annual return, with the share price now down 19% 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 Champion Iron’s P/E Ratio Compare To Its Peers?
We can tell from its P/E ratio of 7.82 that sentiment around Champion Iron isn’t particularly high. We can see in the image below that the average P/E (9.7) for companies in the metals and mining industry is higher than Champion Iron’s P/E.
Champion Iron’s P/E tells us that market participants think it will not fare as well as its peers in the same industry. Many investors like to buy stocks when the market is pessimistic about their prospects. 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
P/E ratios primarily reflect market expectations around earnings growth rates. That’s because companies that grow earnings per share quickly will rapidly increase the ‘E’ in the equation. 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.
It’s nice to see that Champion Iron grew EPS by a stonking 42% in the last year.
Remember: P/E Ratios Don’t Consider The Balance Sheet
Don’t forget that the P/E ratio considers market capitalization. In other words, it does not consider any debt or cash that the company may have on the balance sheet. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
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.
So What Does Champion Iron’s Balance Sheet Tell Us?
Net debt totals just 5.8% of Champion Iron’s market cap. The market might award it a higher P/E ratio if it had net cash, but its unlikely this low level of net borrowing is having a big impact on the P/E multiple.
The Bottom Line On Champion Iron’s P/E Ratio
Champion Iron has a P/E of 7.8. That’s below the average in the AU market, which is 15.9. The EPS growth last year was strong, and debt levels are quite reasonable. If it continues to grow, then the current low P/E may prove to be unjustified. Since analysts are predicting growth will continue, one might expect to see a higher P/E so it may be worth looking closer. What can be absolutely certain is that the market has become more pessimistic about Champion Iron over the last month, with the P/E ratio falling from 11.9 back then to 7.8 today. For those who prefer to invest with the flow of momentum, that might be a bad sign, but for deep value investors this stock might justify some research.
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. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.
Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.
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.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.