A Rising Share Price Has Us Looking Closely At Pitti Engineering Limited's (NSE:PITTIENG) P/E Ratio

Pitti Engineering (NSE:PITTIENG) shares have had a really impressive month, gaining 43%, after some slippage. But shareholders may not all be feeling jubilant, since the share price is still down 36% in the last year.

All else being equal, a sharp share price increase should make a stock less 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). 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.

See our latest analysis for Pitti Engineering

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

We can tell from its P/E ratio of 5.93 that sentiment around Pitti Engineering isn't particularly high. If you look at the image below, you can see Pitti Engineering has a lower P/E than the average (12.5) in the electrical industry classification.

This suggests that market participants think Pitti Engineering 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. When earnings grow, the 'E' increases, over time. That means unless the share price increases, the P/E will reduce in a few years. Then, a lower P/E should attract more buyers, pushing the share price up.

Pitti Engineering's earnings made like a rocket, taking off 68% last year. The cherry on top is that the five year growth rate was an impressive 37% per year. With that kind of growth rate we would generally expect a high P/E ratio. The market might therefore be optimistic about the future, but that doesn't guarantee future growth. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.

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. In other words, it does not consider any debt or cash that the company may have on the balance sheet. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.

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 Pitti Engineering's Debt Impact Its P/E Ratio?

Net debt totals a substantial 151% of Pitti Engineering's market cap. If you want to compare its P/E ratio to other companies, you must keep in mind that these debt levels would usually warrant a relatively low P/E.

The Verdict On Pitti Engineering's P/E Ratio

Pitti Engineering's P/E is 5.9 which is below average (13.9) in the IN market. While the EPS growth last year was strong, the significant debt levels reduce the number of options available to management. The low P/E ratio suggests current market expectations are muted, implying these levels of growth will not continue. What is very clear is that the market has become less pessimistic about Pitti Engineering over the last month, with the P/E ratio rising from 4.2 back then to 5.9 today. 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.

When the market is wrong about a stock, it gives savvy investors an opportunity. 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. We don't have analyst forecasts, but shareholders might want to examine this detailed historical graph of earnings, revenue and cash flow.

Of course you might be able to find a better stock than Pitti Engineering. So you may wish to see this free collection of other companies that have grown earnings strongly.

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.