Unfortunately for some shareholders, the Insperity (NYSE:NSP) share price has dived 50% in the last thirty days. Given the 71% drop over the last year, some shareholders might be worried that they have become bagholders. What is a bagholder? It is a shareholder who has suffered a bad loss, but continues to hold indefinitely, without questioning their reasons for holding, even as the losses grow greater.
All else being equal, a share price drop should make a stock more attractive to potential investors. While the market sentiment towards a stock is very changeable, in the long run, the share price will tend to move in the same direction as earnings per share. 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 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 Insperity Have A Relatively High Or Low P/E For Its Industry?
We can tell from its P/E ratio of 9.38 that sentiment around Insperity isn’t particularly high. The image below shows that Insperity has a lower P/E than the average (11.4) P/E for companies in the professional services industry.
This suggests that market participants think Insperity will underperform other companies in its industry. Since the market seems unimpressed with Insperity, it’s quite possible it could surprise on the upside. If you consider the stock interesting, further research is recommended. For example, 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. When earnings grow, the ‘E’ increases, over time. 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.
Most would be impressed by Insperity earnings growth of 15% in the last year. And its annual EPS growth rate over 5 years is 48%. This could arguably justify a relatively high P/E ratio.
Don’t Forget: The P/E Does Not Account For Debt or Bank Deposits
It’s important to note that the P/E ratio considers the market capitalization, not the enterprise value. 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.
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.
So What Does Insperity’s Balance Sheet Tell Us?
Insperity has net cash of US$133m. That should lead to a higher P/E than if it did have debt, because its strong balance sheets gives it more options.
The Verdict On Insperity’s P/E Ratio
Insperity has a P/E of 9.4. That’s below the average in the US market, which is 12.6. It grew its EPS nicely over the last year, and the healthy balance sheet implies there is more potential for growth. The relatively low P/E ratio implies the market is pessimistic. What can be absolutely certain is that the market has become more pessimistic about Insperity over the last month, with the P/E ratio falling from 18.7 back then to 9.4 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 have an opportunity when market expectations about a stock are wrong. If the reality for a company is not as bad as the P/E ratio indicates, then the share price should increase as the market realizes this. So this free report on the analyst consensus forecasts could help you make a master move on this stock.
But note: Insperity 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 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.
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.