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Micron Technology (NASDAQ:MU) shareholders are no doubt pleased to see that the share price has had a great month, posting a 35% gain, recovering from prior weakness. But shareholders may not all be feeling jubilant, since the share price is still down 21% 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. One way to gauge market expectations of a stock 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.
How Does Micron Technology’s P/E Ratio Compare To Its Peers?
We can tell from its P/E ratio of 4.98 that sentiment around Micron Technology isn’t particularly high. We can see in the image below that the average P/E (22.6) for companies in the semiconductor industry is higher than Micron Technology’s P/E.
Micron Technology’s P/E tells us that market participants think it will not fare as well as its peers in the same industry.
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. And as that P/E ratio drops, the company will look cheap, unless its share price increases.
Micron Technology saw earnings per share decrease by 16% last year. But over the longer term (5 years) earnings per share have increased by 21%.
Remember: P/E Ratios Don’t Consider The Balance Sheet
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. 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.
Micron Technology’s Balance Sheet
The extra options and safety that comes with Micron Technology’s US$1.8b 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 Micron Technology’s P/E Ratio
Micron Technology trades on a P/E ratio of 5, which is below the US market average of 18. Falling earnings per share are likely to be keeping potential buyers away, but the net cash position means the company has time to improve: if so, the low P/E could be an opportunity. What we know for sure is that investors are becoming rather less uncomfortable about Micron Technology’s prospects, since they have pushed its P/E ratio from 3.7 to 5 over the last month. If you like to buy stocks that could be turnaround opportunities, then this one might be a candidate; but if you’re more sensitive to price, then you may feel the opportunity has passed.
Investors should be looking to buy stocks that the market is wrong about. 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: Micron Technology 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).
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.
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. Thank you for reading.