How Does Ramkrishna Forgings's (NSE:RKFORGE) P/E Compare To Its Industry, After The Share Price Drop?

To the annoyance of some shareholders, Ramkrishna Forgings (NSE:RKFORGE) shares are down a considerable 34% in the last month. That drop has capped off a tough year for shareholders, with the share price down 49% in that time.

All else being equal, a share price drop should make a stock more 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). So, on certain occasions, long term focussed investors try to take advantage of pessimistic expectations to buy shares at a better price. 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.

See our latest analysis for Ramkrishna Forgings

Does Ramkrishna Forgings Have A Relatively High Or Low P/E For Its Industry?

We can tell from its P/E ratio of 9.49 that there is some investor optimism about Ramkrishna Forgings. As you can see below, Ramkrishna Forgings has a higher P/E than the average company (8.2) in the metals and mining industry.

Its relatively high P/E ratio indicates that Ramkrishna Forgings shareholders think it will perform better than other companies in its industry classification.

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. When earnings grow, the 'E' increases, over time. And in that case, the P/E ratio itself will drop rather quickly. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.

Ramkrishna Forgings increased earnings per share by 2.0% last year. And earnings per share have improved by 58% annually, over the last five years.

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. So it won't reflect the advantage of cash, or disadvantage of debt. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.

Such spending might be good or bad, overall, but the key point here is that you need to look at debt to understand the P/E ratio in context.

Ramkrishna Forgings's Balance Sheet

Net debt totals 74% of Ramkrishna Forgings's market cap. This is a reasonably significant level of debt -- all else being equal you'd expect a much lower P/E than if it had net cash.

The Verdict On Ramkrishna Forgings's P/E Ratio

Ramkrishna Forgings has a P/E of 9.5. That's below the average in the IN market, which is 13. It's good to see EPS growth in the last 12 months, but the debt on the balance sheet might be muting expectations. Given Ramkrishna Forgings's P/E ratio has declined from 14.3 to 9.5 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 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.' So this free visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.

Of course you might be able to find a better stock than Ramkrishna Forgings. 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.