To the annoyance of some shareholders, GAIL (India) (NSE:GAIL) shares are down a considerable 38% in the last month. That drop has capped off a tough year for shareholders, with the share price down 55% 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). The implication here is that long term investors have an opportunity when expectations of a company are too low. 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). 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.
Does GAIL (India) Have A Relatively High Or Low P/E For Its Industry?
GAIL (India)’s P/E of 5.80 indicates relatively low sentiment towards the stock. We can see in the image below that the average P/E (15.3) for companies in the gas utilities industry is higher than GAIL (India)’s P/E.
This suggests that market participants think GAIL (India) will underperform other companies in its industry. Many investors like to buy stocks when the market is pessimistic about their prospects. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.
How Growth Rates Impact P/E Ratios
Generally speaking the rate of earnings growth has a profound impact on a company’s P/E multiple. When earnings grow, the ‘E’ increases, over time. That means unless the share price increases, the P/E will reduce in a few years. A lower P/E should indicate the stock is cheap relative to others — and that may attract buyers.
GAIL (India) maintained roughly steady earnings over the last twelve months. But EPS is up 14% over the last 5 years.
Remember: P/E Ratios Don’t Consider The Balance Sheet
Don’t forget that the P/E ratio considers market capitalization. That means it doesn’t take debt or cash into account. 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.
So What Does GAIL (India)’s Balance Sheet Tell Us?
The extra options and safety that comes with GAIL (India)’s ₹6.7b net cash position means that it deserves a higher P/E than it would if it had a lot of net debt.
The Bottom Line On GAIL (India)’s P/E Ratio
GAIL (India) trades on a P/E ratio of 5.8, which is below the IN market average of 11.7. Recent earnings growth wasn’t bad. And the healthy balance sheet means the company can sustain growth while the P/E suggests shareholders don’t think it will. What can be absolutely certain is that the market has become more pessimistic about GAIL (India) over the last month, with the P/E ratio falling from 9.4 back then to 5.8 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.
Investors should be looking to buy stocks that the market is wrong about. 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: GAIL (India) 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 email@example.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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