To the annoyance of some shareholders, Agro Tech Foods (NSE:ATFL) shares are down a considerable 38% in the last month. That drop has capped off a tough year for shareholders, with the share price down 33% in that time.
Assuming nothing else has changed, a lower share price makes a stock more 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). 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). 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.
Does Agro Tech Foods Have A Relatively High Or Low P/E For Its Industry?
Agro Tech Foods’s P/E of 24.02 indicates some degree of optimism towards the stock. The image below shows that Agro Tech Foods has a higher P/E than the average (10.3) P/E for companies in the food industry.
Its relatively high P/E ratio indicates that Agro Tech Foods shareholders think it will perform better than other companies in its industry classification. The market is optimistic about the future, but that doesn’t guarantee future growth. So investors should delve deeper. I like to check if company insiders have been buying or selling.
How Growth Rates Impact P/E Ratios
Generally speaking the rate of earnings growth has a profound impact on a company’s P/E multiple. 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. A lower P/E should indicate the stock is cheap relative to others — and that may attract buyers.
Most would be impressed by Agro Tech Foods earnings growth of 14% in the last year. And its annual EPS growth rate over 5 years is 1.5%. This could arguably justify a relatively high P/E ratio.
Don’t Forget: The P/E Does Not Account For Debt or Bank Deposits
Don’t forget that the P/E ratio considers market capitalization. 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.
So What Does Agro Tech Foods’s Balance Sheet Tell Us?
Since Agro Tech Foods holds net cash of ₹404m, it can spend on growth, justifying a higher P/E ratio than otherwise.
The Bottom Line On Agro Tech Foods’s P/E Ratio
Agro Tech Foods has a P/E of 24.0. That’s higher than the average in its market, which is 9.2. With cash in the bank the company has plenty of growth options — and it is already on the right track. Therefore it seems reasonable that the market would have relatively high expectations of the company What can be absolutely certain is that the market has become significantly less optimistic about Agro Tech Foods over the last month, with the P/E ratio falling from 38.6 back then to 24.0 today. 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. People often underestimate remarkable growth — so investors can make money when fast growth is not fully appreciated. So this free report on the analyst consensus forecasts could help you make a master move on this stock.
Of course you might be able to find a better stock than Agro Tech Foods. 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 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.
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