Unfortunately for some shareholders, the Bharat Heavy Electricals (NSE:BHEL) share price has dived 31% in the last thirty days. That drop has capped off a tough year for shareholders, with the share price down 54% in that time.
All else being equal, a share price drop should make a stock more attractive to potential investors. 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). Investors have optimistic expectations of companies with higher P/E ratios, compared to companies with lower P/E ratios.
See our latest analysis for Bharat Heavy Electricals
How Does Bharat Heavy Electricals's P/E Ratio Compare To Its Peers?
Bharat Heavy Electricals's P/E of 14.79 indicates some degree of optimism towards the stock. As you can see below, Bharat Heavy Electricals has a higher P/E than the average company (13.5) in the electrical industry.
Bharat Heavy Electricals's P/E tells us that market participants think the company will perform better than its industry peers, going forward. Shareholders are clearly optimistic, but the future is always uncertain. So further research is always essential. I often monitor director buying and selling.
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. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
Bharat Heavy Electricals saw earnings per share decrease by 14% last year. But it has grown its earnings per share by 18% per year over the last three years. And EPS is down 12% a year, over the last 5 years. This might lead to muted expectations.
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. Thus, the metric does not reflect cash or debt held by the company. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
While growth expenditure doesn't always pay off, the point is that it is a good option to have; but one that the P/E ratio ignores.
How Does Bharat Heavy Electricals's Debt Impact Its P/E Ratio?
With net cash of ₹24b, Bharat Heavy Electricals 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 Bharat Heavy Electricals's P/E Ratio
Bharat Heavy Electricals has a P/E of 14.8. That's higher than the average in its market, which is 12.6. The recent drop in earnings per share would make some investors cautious, but the healthy balance sheet means the company retains potential for future growth. If fails to eventuate, the current high P/E could prove to be temporary, as the share price falls. Given Bharat Heavy Electricals's P/E ratio has declined from 21.3 to 14.8 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. 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 report on the analyst consensus forecasts could help you make a master move on this stock.
But note: Bharat Heavy Electricals 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).
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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