To the annoyance of some shareholders, Peet (ASX:PPC) shares are down a considerable 32% in the last month. The recent drop has obliterated the annual return, with the share price now down 16% over that longer period.
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. 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). Investors have optimistic expectations of companies with higher P/E ratios, compared to companies with lower P/E ratios.
How Does Peet's P/E Ratio Compare To Its Peers?
Peet's P/E of 13.52 indicates some degree of optimism towards the stock. You can see in the image below that the average P/E (12.4) for companies in the real estate industry is lower than Peet's P/E.
Peet's P/E tells us that market participants think the company will perform better than its industry peers, going forward. 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
When earnings fall, the 'E' decreases, over time. That means unless the share price falls, the P/E will increase in a few years. Then, a higher P/E might scare off shareholders, pushing the share price down.
Peet saw earnings per share decrease by 41% last year. And over the longer term (5 years) earnings per share have decreased 4.7% annually. This could justify a pessimistic P/E.
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. 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.
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.
How Does Peet's Debt Impact Its P/E Ratio?
Peet has net debt worth 65% of its market capitalization. If you want to compare its P/E ratio to other companies, you should absolutely keep in mind it has significant borrowings.
The Verdict On Peet's P/E Ratio
Peet has a P/E of 13.5. That's around the same as the average in the AU market, which is 13.0. With relatively high debt, and no earnings per share growth over twelve months, the P/E suggests that many have an expectation that company will find some growth. Given Peet's P/E ratio has declined from 20.0 to 13.5 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.
When the market is wrong about a stock, it gives savvy investors an opportunity. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. So this free report on the analyst consensus forecasts could help you make a master move on this stock.
You might be able to find a better buy than Peet. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
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