Unfortunately for some shareholders, the Reliance Worldwide (ASX:RWC) share price has dived 32% in the last thirty days. That drop has capped off a tough year for shareholders, with the share price down 30% in that time.
Assuming nothing else has changed, a lower share price makes a stock more attractive to potential buyers. 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). Investors have optimistic expectations of companies with higher P/E ratios, compared to companies with lower P/E ratios.
Check out our latest analysis for Reliance Worldwide
How Does Reliance Worldwide’s P/E Ratio Compare To Its Peers?
We can tell from its P/E ratio of 21.63 that there is some investor optimism about Reliance Worldwide. As you can see below, Reliance Worldwide has a higher P/E than the average company (14.8) in the building industry.
Its relatively high P/E ratio indicates that Reliance Worldwide shareholders think it will perform better than other companies in its industry classification. The market is optimistic about the future, but that doesn’t guarantee future growth. So further research is always essential. I often monitor director buying and selling.
How Growth Rates Impact P/E Ratios
Earnings growth rates have a big influence on P/E ratios. If earnings are growing quickly, then the ‘E’ in the equation will increase faster than it would otherwise. And in that case, the P/E ratio itself will drop rather quickly. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
It’s great to see that Reliance Worldwide grew EPS by 11% in the last year. And it has improved its earnings per share by 374% per year over the last three years. This could arguably justify a relatively high P/E ratio.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
It’s important to note that the P/E ratio considers the market capitalization, not the enterprise value. In other words, it does not consider any debt or cash that the company may have on the balance sheet. 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 Reliance Worldwide’s Debt Impact Its P/E Ratio?
Reliance Worldwide has net debt worth 16% of its market capitalization. This could bring some additional risk, and reduce the number of investment options for management; worth remembering if you compare its P/E to businesses without debt.
The Verdict On Reliance Worldwide’s P/E Ratio
Reliance Worldwide trades on a P/E ratio of 21.6, which is above its market average of 17.2. Its debt levels do not imperil its balance sheet and it is growing EPS strongly. Therefore, it’s not particularly surprising that it has a above average P/E ratio. Given Reliance Worldwide’s P/E ratio has declined from 31.8 to 21.6 in the last month, we know for sure that the market is significantly less confident about the business today, than it was back then. 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 should be looking to buy stocks that the market is wrong about. 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 visual report on analyst forecasts could hold the key to an excellent investment decision.
Of course you might be able to find a better stock than Reliance Worldwide. So you may wish to see this free collection of other companies that have grown earnings strongly.
If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.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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