A Sliding Share Price Has Us Looking At Century Textiles and Industries Limited's (NSE:CENTURYTEX) P/E Ratio

To the annoyance of some shareholders, Century Textiles and Industries (NSE:CENTURYTEX) shares are down a considerable 55% in the last month. Indeed the recent decline has arguably caused some bitterness for shareholders who have held through the 52% drop over twelve months.

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. 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.

View our latest analysis for Century Textiles and Industries

How Does Century Textiles and Industries's P/E Ratio Compare To Its Peers?

Century Textiles and Industries's P/E of 9.97 indicates relatively low sentiment towards the stock. We can see in the image below that the average P/E (20.1) for companies in the basic materials industry is higher than Century Textiles and Industries's P/E.

This suggests that market participants think Century Textiles and Industries will underperform other companies in its industry.

How Growth Rates Impact P/E Ratios

Probably the most important factor in determining what P/E a company trades on is the earnings growth. 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. And as that P/E ratio drops, the company will look cheap, unless its share price increases.

Century Textiles and Industries's 57% EPS improvement over the last year was like bamboo growth after rain; rapid and impressive. The cherry on top is that the five year growth rate was an impressive 63% per year. So I'd be surprised if the P/E ratio was not above average. The market might expect further growth, but it isn't guaranteed. So investors should delve deeper. I like to check if company insiders have been buying or selling.

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. That means it doesn't take debt or cash into account. 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.

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).

Century Textiles and Industries's Balance Sheet

Century Textiles and Industries's net debt is 5.1% of its market cap. It would probably trade on a higher P/E ratio if it had a lot of cash, but I doubt it is having a big impact.

The Verdict On Century Textiles and Industries's P/E Ratio

Century Textiles and Industries's P/E is 10.0 which is below average (13.1) in the IN market. The company does have a little debt, and EPS growth was good last year. The low P/E ratio suggests current market expectations are muted, implying these levels of growth will not continue. Given Century Textiles and Industries's P/E ratio has declined from 22.3 to 10.0 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.

Investors should be looking to buy stocks that the market is wrong about. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.

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

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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.