Unfortunately for some shareholders, the Smiths Group (LON:SMIN) share price has dived 33% in the last thirty days. The recent drop has obliterated the annual return, with the share price now down 23% 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.
Does Smiths Group Have A Relatively High Or Low P/E For Its Industry?
We can tell from its P/E ratio of 31.19 that there is some investor optimism about Smiths Group. The image below shows that Smiths Group has a higher P/E than the average (11.3) P/E for companies in the industrials industry.
Smiths Group’s P/E tells us that market participants think the company will perform better than its industry peers, going forward. Clearly the market expects growth, but it isn’t guaranteed. So investors should delve deeper. I like to check if company insiders have been buying or selling.
How Growth Rates Impact P/E Ratios
If earnings fall then in the future the ‘E’ will be lower. That means unless the share price falls, the P/E will increase in a few years. A higher P/E should indicate the stock is expensive relative to others — and that may encourage shareholders to sell.
It’s great to see that Smiths Group grew EPS by 20% in the last year. In contrast, EPS has decreased by 9.8%, annually, over 5 years.
Remember: P/E Ratios Don’t Consider The Balance Sheet
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. That means it doesn’t take debt or cash into account. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.
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.
Smiths Group’s Balance Sheet
Smiths Group has net debt equal to 28% of its market cap. You’d want to be aware of this fact, but it doesn’t bother us.
The Bottom Line On Smiths Group’s P/E Ratio
Smiths Group has a P/E of 31.2. That’s higher than the average in its market, which is 12.5. While the company does use modest debt, its recent earnings growth is very good. So on this analysis it seems reasonable that its P/E ratio is above average. Given Smiths Group’s P/E ratio has declined from 46.9 to 31.2 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. People often underestimate remarkable growth — so investors can make money when fast growth is not fully appreciated. 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.
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