How Does Tekcapital's (LON:TEK) P/E Compare To Its Industry, After The Share Price Drop?

To the annoyance of some shareholders, Tekcapital (LON:TEK) shares are down a considerable 33% in the last month. The recent drop has obliterated the annual return, with the share price now down 26% 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). So, on certain occasions, long term focussed investors try to take advantage of pessimistic expectations to buy shares at a better price. 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.

Check out our latest analysis for Tekcapital

Does Tekcapital Have A Relatively High Or Low P/E For Its Industry?

Tekcapital's P/E of 0.93 indicates relatively low sentiment towards the stock. We can see in the image below that the average P/E (18.4) for companies in the professional services industry is higher than Tekcapital's P/E.

This suggests that market participants think Tekcapital will underperform other companies in its industry.

How Growth Rates Impact P/E Ratios

P/E ratios primarily reflect market expectations around earnings growth rates. Earnings growth means that in the future the 'E' will be higher. That means even if the current P/E is high, it will reduce over time if the share price stays flat. And as that P/E ratio drops, the company will look cheap, unless its share price increases.

Tekcapital's earnings per share fell by 1.4% in the last twelve months.

A Limitation: P/E Ratios Ignore Debt and Cash In The Bank

Don't forget that the P/E ratio considers market capitalization. So it won't reflect the advantage of cash, or disadvantage of debt. The exact same company would hypothetically deserve a higher P/E ratio if it had a strong balance sheet, than if it had a weak one with lots of debt, because a cashed up company can spend on 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.

How Does Tekcapital's Debt Impact Its P/E Ratio?

With net cash of US$1.2m, Tekcapital has a very strong balance sheet, which may be important for its business. Having said that, at 22% of its market capitalization the cash hoard would contribute towards a higher P/E ratio.

The Verdict On Tekcapital's P/E Ratio

Tekcapital's P/E is 0.9 which is below average (16.3) in the GB market. The recent drop in earnings per share would make investors cautious, the relatively strong balance sheet will allow the company time to invest in growth. If it achieves that, then there's real potential that the low P/E could eventually indicate undervaluation. Given Tekcapital's P/E ratio has declined from 1.4 to 0.9 in the last month, we know for sure that the market is more worried 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 deep value investors this stock might justify some research.

When the market is wrong about a stock, it gives savvy investors an opportunity. 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.' Although we don't have analyst forecasts, you could get a better understanding of its growth by checking out this more detailed historical graph of earnings, revenue and cash flow.

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.

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 editorial-team@simplywallst.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.