Is Terra Firma Capital Corporation's (CVE:TII) P/E Ratio Really That Good?

Of late the Terra Firma Capital (CVE:TII) share price has softened like an ice cream in the sun, melting a full . But there's still good reason for shareholders to be content; the stock has gained 9.0% in the last 90 days. Looking back further, the stock is up 5.5% in the last year.

Assuming no other changes, a sharply higher share price makes a stock less 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 some would prefer to hold off buying when there is a lot of optimism towards a stock. 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). 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 Terra Firma Capital

Does Terra Firma Capital Have A Relatively High Or Low P/E For Its Industry?

Terra Firma Capital's P/E of 6.27 indicates relatively low sentiment towards the stock. If you look at the image below, you can see Terra Firma Capital has a lower P/E than the average (13.0) in the mortgage industry classification.

This suggests that market participants think Terra Firma Capital will underperform other companies in its industry. Many investors like to buy stocks when the market is pessimistic about their prospects. You should delve deeper. I like to check if company insiders have been buying or selling.

How Growth Rates Impact P/E Ratios

Probably the most important factor in determining what P/E a company trades on is the earnings growth. Earnings growth means that in the future the 'E' will be higher. That means unless the share price increases, the P/E will reduce in a few years. And as that P/E ratio drops, the company will look cheap, unless its share price increases.

In the last year, Terra Firma Capital grew EPS like Taylor Swift grew her fan base back in 2010; the 346% gain was both fast and well deserved. Even better, EPS is up 22% per year over three years. So we'd absolutely expect it to have a relatively high P/E ratio. Unfortunately, earnings per share are down 3.8% a year, over 5 years.

Remember: P/E Ratios Don't Consider The Balance Sheet

Don't forget that the P/E ratio considers market capitalization. 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.

Spending on growth might be good or bad a few years later, but the point is that the P/E ratio does not account for the option (or lack thereof).

How Does Terra Firma Capital's Debt Impact Its P/E Ratio?

Terra Firma Capital's net debt is considerable, at 386% of its market cap. This is a relatively high level of debt, so the stock probably deserves a relatively low P/E ratio. Keep that in mind when comparing it to other companies.

The Verdict On Terra Firma Capital's P/E Ratio

Terra Firma Capital has a P/E of 6.3. That's below the average in the CA market, which is 15.8. The company may have significant debt, but EPS growth was good last year. If it continues to grow, then the current low P/E may prove to be unjustified. What can be absolutely certain is that the market has become more pessimistic about Terra Firma Capital over the last month, with the P/E ratio falling from 6.3 back then to 6.3 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.

When the market is wrong about a stock, it gives savvy investors an opportunity. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. So this free visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.

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 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.

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.