How Does AFH Financial Group's (LON:AFHP) P/E Compare To Its Industry, After The Share Price Drop?

To the annoyance of some shareholders, AFH Financial Group (LON:AFHP) shares are down a considerable 30% in the last month. The recent drop has obliterated the annual return, with the share price now down 12% over that longer period.

Assuming nothing else has changed, a lower share price makes a stock more 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 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 implies that investors have high expectations of what a company can achieve compared to a company with a low P/E ratio.

View our latest analysis for AFH Financial Group

Does AFH Financial Group Have A Relatively High Or Low P/E For Its Industry?

We can tell from its P/E ratio of 11.51 that sentiment around AFH Financial Group isn't particularly high. We can see in the image below that the average P/E (16.2) for companies in the capital markets industry is higher than AFH Financial Group's P/E.

AFH Financial Group's P/E tells us that market participants think it will not fare as well as its peers in the same industry. Many investors like to buy stocks when the market is pessimistic about their prospects. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.

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. That's because companies that grow earnings per share quickly will rapidly increase the 'E' in the equation. And in that case, the P/E ratio itself will drop rather quickly. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.

In the last year, AFH Financial Group grew EPS like Taylor Swift grew her fan base back in 2010; the 59% gain was both fast and well deserved. The cherry on top is that the five year growth rate was an impressive 50% per year. So I'd be surprised if the P/E ratio was not above average.

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

Don't forget that the P/E ratio considers market capitalization. That means it doesn't take debt or cash into account. 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).

So What Does AFH Financial Group's Balance Sheet Tell Us?

Net debt totals just 3.2% of AFH Financial Group's market cap. The market might award it a higher P/E ratio if it had net cash, but its unlikely this low level of net borrowing is having a big impact on the P/E multiple.

The Verdict On AFH Financial Group's P/E Ratio

AFH Financial Group trades on a P/E ratio of 11.5, which is below the GB market average of 13.9. The EPS growth last year was strong, and debt levels are quite reasonable. If it continues to grow, then the current low P/E may prove to be unjustified. Since analysts are predicting growth will continue, one might expect to see a higher P/E so it may be worth looking closer. Given AFH Financial Group's P/E ratio has declined from 16.5 to 11.5 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 don't like to trade against momentum, that could be a warning sign, but a contrarian investor might want to take a closer look.

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 visual report on analyst forecasts could hold the key to an excellent investment decision.

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.

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.

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