Unfortunately for some shareholders, the Arconic (NYSE:ARNC) share price has dived 31% in the last thirty days. Looking back over the last year, the stock has been a solid performer, with a gain of 17%.
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. 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.
How Does Arconic’s P/E Ratio Compare To Its Peers?
Arconic’s P/E of 21.07 indicates some degree of optimism towards the stock. The image below shows that Arconic has a higher P/E than the average (16.2) P/E for companies in the aerospace & defense industry.
Its relatively high P/E ratio indicates that Arconic 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
P/E ratios primarily reflect market expectations around earnings growth rates. When earnings grow, the ‘E’ increases, over time. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. Then, a lower P/E should attract more buyers, pushing the share price up.
Arconic shrunk earnings per share by 21% over the last year.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. Thus, the metric does not reflect cash or debt held by the company. Theoretically, a business can improve its earnings (and produce a lower P/E in the future) by investing in growth. That means taking on debt (or spending its cash).
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.
Arconic’s Balance Sheet
Arconic’s net debt equates to 45% of its market capitalization. You’d want to be aware of this fact, but it doesn’t bother us.
The Bottom Line On Arconic’s P/E Ratio
Arconic trades on a P/E ratio of 21.1, which is above its market average of 14.7. With some debt but no EPS growth last year, the market has high expectations of future profits. What can be absolutely certain is that the market has become significantly less optimistic about Arconic over the last month, with the P/E ratio falling from 30.5 back then to 21.1 today. 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.
When the market is wrong about a stock, it gives savvy investors an opportunity. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. 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.
You might be able to find a better buy than Arconic. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
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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