Stelmet (WSE:STL) shares have had a really impressive month, gaining 33%, after some slippage. Unfortunately, the full year gain of 3.7% wasn’t so sweet.
Assuming no other changes, a sharply higher share price makes a stock less attractive to potential buyers. 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 deep value investors might steer clear when expectations of a company are too high. One way to gauge market expectations of a stock 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.
Does Stelmet Have A Relatively High Or Low P/E For Its Industry?
Stelmet’s P/E of 23.36 indicates some degree of optimism towards the stock. As you can see below, Stelmet has a higher P/E than the average company (16.5) in the forestry industry.
Its relatively high P/E ratio indicates that Stelmet shareholders think it will perform better than other companies in its industry classification.
How Growth Rates Impact P/E Ratios
When earnings fall, the ‘E’ decreases, over time. That means even if the current P/E is low, it will increase over time if the share price stays flat. Then, a higher P/E might scare off shareholders, pushing the share price down.
Stelmet saw earnings per share improve by -2.1% last year. Unfortunately, earnings per share are down 36% a year, over 5 years.
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. So it won’t reflect the advantage of cash, or disadvantage of debt. 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).
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).
Stelmet’s Balance Sheet
Stelmet has net debt worth 79% of its market capitalization. If you want to compare its P/E ratio to other companies, you should absolutely keep in mind it has significant borrowings.
The Bottom Line On Stelmet’s P/E Ratio
Stelmet’s P/E is 23.4 which is above average (10.6) in its market. With significant debt and fairly modest EPS growth last year, shareholders are betting on sustained improvement. What we know for sure is that investors have become much more excited about Stelmet recently, since they have pushed its P/E ratio from 17.5 to 23.4 over the last month. If you like to buy stocks that have recently impressed the market, then this one might be a candidate; but if you prefer to invest when there is ‘blood in the streets’, then you may feel the opportunity has passed.
Investors should be looking to buy stocks that the market is wrong about. As value investor Benjamin Graham famously said, ‘In the short run, the market is a voting machine but in the long run, it is a weighing machine.’ 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.
But note: Stelmet 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).
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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. Thank you for reading.