To the annoyance of some shareholders, Vascon Engineers (NSE:VASCONEQ) shares are down a considerable 35% in the last month. And that drop will have no doubt have some shareholders concerned that the 61% share price decline, over the last year, has turned them into bagholders. For those wondering, a bagholder is someone who keeps holding a losing stock indefinitely, without taking the time to consider its prospects carefully, going forward.
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. 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 implies that investors have high expectations of what a company can achieve compared to a company with a low P/E ratio.
How Does Vascon Engineers’s P/E Ratio Compare To Its Peers?
We can tell from its P/E ratio of 27.56 that there is some investor optimism about Vascon Engineers. You can see in the image below that the average P/E (13.8) for companies in the construction industry is lower than Vascon Engineers’s P/E.
Its relatively high P/E ratio indicates that Vascon Engineers shareholders think it will perform better than other companies in its industry classification.
How Growth Rates Impact P/E Ratios
Companies that shrink earnings per share quickly will rapidly decrease the ‘E’ in the equation. Therefore, even if you pay a low multiple of earnings now, that multiple will become higher in the future. So while a stock may look cheap based on past earnings, it could be expensive based on future earnings.
It’s great to see that Vascon Engineers grew EPS by 16% in the last year. Unfortunately, earnings per share are down 14% a year, over 3 years.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
It’s important to note that the P/E ratio considers the market capitalization, not the enterprise value. 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.
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).
Vascon Engineers’s Balance Sheet
Net debt is 30% of Vascon Engineers’s market cap. While it’s worth keeping this in mind, it isn’t a worry.
The Bottom Line On Vascon Engineers’s P/E Ratio
Vascon Engineers has a P/E of 27.6. That’s higher than the average in its market, which is 13.8. While the company does use modest debt, its recent earnings growth is very good. Therefore, it’s not particularly surprising that it has a above average P/E ratio. Given Vascon Engineers’s P/E ratio has declined from 42.6 to 27.6 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 have an opportunity when market expectations about a stock are wrong. 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.’ We don’t have analyst forecasts, but you might want to assess this data-rich visualization 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 firstname.lastname@example.org. 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.