To the annoyance of some shareholders, Midwich Group (LON:MIDW) shares are down a considerable 31% in the last month. That drop has capped off a tough year for shareholders, with the share price down 32% in that time.
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. 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 Midwich Group’s P/E Ratio Compare To Its Peers?
Midwich Group’s P/E of 17.99 indicates some degree of optimism towards the stock. As you can see below, Midwich Group has a higher P/E than the average company (16.6) in the electronic industry.
Its relatively high P/E ratio indicates that Midwich Group 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. If earnings are growing quickly, then the ‘E’ in the equation will increase faster than it would otherwise. 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.
Midwich Group increased earnings per share by an impressive 17% over the last twelve months. And earnings per share have improved by 26% annually, over the last three years. This could arguably justify a relatively high P/E ratio. But earnings per share are down 50% per year over the last five 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. 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.
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.
How Does Midwich Group’s Debt Impact Its P/E Ratio?
Midwich Group’s net debt is 16% of its market cap. It would probably deserve a higher P/E ratio if it was net cash, since it would have more options for growth.
The Bottom Line On Midwich Group’s P/E Ratio
Midwich Group has a P/E of 18.0. That’s higher than the average in its market, which is 12.5. 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 Midwich Group’s P/E ratio has declined from 25.9 to 18.0 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 should be looking to buy stocks that the market is wrong about. People often underestimate remarkable growth — so investors can make money when fast growth is not fully appreciated. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.
But note: Midwich Group may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
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.
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. Thank you for reading.
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