Unfortunately for some shareholders, the McGrath RentCorp (NASDAQ:MGRC) share price has dived 32% in the last thirty days. The recent drop has obliterated the annual return, with the share price now down 10% 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). 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). Investors have optimistic expectations of companies with higher P/E ratios, compared to companies with lower P/E ratios.
See our latest analysis for McGrath RentCorp
How Does McGrath RentCorp’s P/E Ratio Compare To Its Peers?
McGrath RentCorp’s P/E of 12.91 indicates relatively low sentiment towards the stock. If you look at the image below, you can see McGrath RentCorp has a lower P/E than the average (20.8) in the commercial services industry classification.
Its relatively low P/E ratio indicates that McGrath RentCorp shareholders think it will struggle to do as well as other companies in its industry classification. Since the market seems unimpressed with McGrath RentCorp, it’s quite possible it could surprise on the upside. You should delve deeper. I like to check if company insiders have been buying or selling.
How Growth Rates Impact P/E Ratios
P/E ratios primarily reflect market expectations around earnings growth rates. That’s because companies that grow earnings per share quickly will rapidly increase the ‘E’ in the equation. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. A lower P/E should indicate the stock is cheap relative to others — and that may attract buyers.
It’s great to see that McGrath RentCorp grew EPS by 21% in the last year. And it has bolstered its earnings per share by 18% per year over the last five years. This could arguably justify a relatively high P/E ratio.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
The ‘Price’ in P/E reflects the market capitalization of the company. In other words, it does not consider any debt or cash that the company may have on the balance sheet. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
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).
McGrath RentCorp’s Balance Sheet
McGrath RentCorp’s net debt is 23% of its market cap. That’s enough debt to impact the P/E ratio a little; so keep it in mind if you’re comparing it to companies without debt.
The Bottom Line On McGrath RentCorp’s P/E Ratio
McGrath RentCorp’s P/E is 12.9 which is about average (12.6) in the US market. When you consider the impressive EPS growth last year (along with some debt), it seems the market has questions about whether rapid EPS growth will be sustained. Given McGrath RentCorp’s P/E ratio has declined from 19.0 to 12.9 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 prefer to invest with the flow of momentum, that might be a bad sign, but for a contrarian, it may signal opportunity.
When the market is wrong about a stock, it gives savvy investors an opportunity. People often underestimate remarkable growth — so investors can make money when fast growth is not fully appreciated. So this free report on the analyst consensus forecasts could help you make a master move on this stock.
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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