Unfortunately for some shareholders, the Redrow (LON:RDW) share price has dived 31% in the last thirty days. Even longer term holders have taken a real hit with the stock declining 17% in the last year.
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 implies that investors have high expectations of what a company can achieve compared to a company with a low P/E ratio.
How Does Redrow’s P/E Ratio Compare To Its Peers?
Redrow’s P/E of 6.32 indicates relatively low sentiment towards the stock. The image below shows that Redrow has a lower P/E than the average (9.8) P/E for companies in the consumer durables industry.
Its relatively low P/E ratio indicates that Redrow shareholders think it will struggle to do as well as other companies in its industry classification. Since the market seems unimpressed with Redrow, 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
Earnings growth rates have a big influence on P/E ratios. Earnings growth means that in the future the ‘E’ will be higher. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
Redrow shrunk earnings per share by 5.8% last year. But over the longer term (5 years) earnings per share have increased by 16%.
Remember: P/E Ratios Don’t Consider The Balance Sheet
It’s important to note that the P/E ratio considers the market capitalization, not the enterprise value. 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.
Such spending might be good or bad, overall, but the key point here is that you need to look at debt to understand the P/E ratio in context.
Redrow’s Balance Sheet
Since Redrow holds net cash of UK£14m, it can spend on growth, justifying a higher P/E ratio than otherwise.
The Bottom Line On Redrow’s P/E Ratio
Redrow trades on a P/E ratio of 6.3, which is below the GB market average of 13.9. Falling earnings per share are likely to be keeping potential buyers away, but the net cash position means the company has time to improve: if so, the low P/E could be an opportunity. Given Redrow’s P/E ratio has declined from 9.1 to 6.3 in the last month, we know for sure that the market is more worried about the business today, than it was back then. 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 have an opportunity when market expectations about a stock are wrong. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. So this free report on the analyst consensus forecasts could help you make a master move on this stock.
But note: Redrow may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
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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