Otelco (NASDAQ:OTEL) shareholders are no doubt pleased to see that the share price has bounced 32% in the last month alone, although it is still down 12% over the last quarter. But shareholders may not all be feeling jubilant, since the share price is still down 49% in the last year.
Assuming no other changes, a sharply higher share price makes a stock less attractive to potential buyers. 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 some would prefer to hold off buying when there is a lot of optimism towards a stock. 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 ratio means that investors have a high expectation about future growth, while a low P/E ratio means they have low expectations about future growth.
View our latest analysis for Otelco
How Does Otelco's P/E Ratio Compare To Its Peers?
We can tell from its P/E ratio of 3.49 that sentiment around Otelco isn't particularly high. If you look at the image below, you can see Otelco has a lower P/E than the average (12.8) in the telecom industry classification.
Otelco's P/E tells us that market participants think it will not fare as well as its peers in the same industry. Since the market seems unimpressed with Otelco, it's quite possible it could surprise on the upside. You should delve deeper. I like to check if company insiders have been buying or selling.
How Growth Rates Impact P/E Ratios
P/E ratios primarily reflect market expectations around earnings growth rates. That's because companies that grow earnings per share quickly will rapidly increase the 'E' in the equation. 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.
Otelco saw earnings per share decrease by 21% last year. But it has grown its earnings per share by 4.2% per year over the last five years.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
The 'Price' in P/E reflects the market capitalization of the company. So it won't reflect the advantage of cash, or disadvantage of debt. 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.
So What Does Otelco's Balance Sheet Tell Us?
Net debt totals a substantial 236% of Otelco'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 Otelco's P/E Ratio
Otelco has a P/E of 3.5. That's below the average in the US market, which is 15.1. The P/E reflects market pessimism that probably arises from the lack of recent EPS growth, paired with significant leverage. What is very clear is that the market has become less pessimistic about Otelco over the last month, with the P/E ratio rising from 2.6 back then to 3.5 today. For those who like to invest in turnarounds, that might mean it's time to put the stock on a watchlist, or research it. But others might consider the opportunity to have passed.
Investors should be looking to buy stocks that the market is wrong about. 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 be able to find a better stock than Otelco. So you may wish to see this free collection of other companies that have grown earnings strongly.
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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