To the annoyance of some shareholders, Sydney Airport (ASX:SYD) shares are down a considerable 31% in the last month. The recent drop has obliterated the annual return, with the share price now down 29% 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). 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 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 Sydney Airport Have A Relatively High Or Low P/E For Its Industry?
Sydney Airport's P/E of 28.84 indicates relatively low sentiment towards the stock. If you look at the image below, you can see Sydney Airport has a lower P/E than the average (31.6) in the infrastructure industry classification.
Sydney Airport's P/E tells us that market participants think it will not fare as well as its peers in the same industry. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. You 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. Then, a lower P/E should attract more buyers, pushing the share price up.
Sydney Airport saw earnings per share improve by 8.3% last year. And its annual EPS growth rate over 5 years is 46%.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. 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.
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.
Is Debt Impacting Sydney Airport's P/E?
Sydney Airport's net debt is 87% of its 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 Sydney Airport's P/E Ratio
Sydney Airport trades on a P/E ratio of 28.8, which is above its market average of 13.0. With significant debt and fairly modest EPS growth last year, shareholders are betting on sustained improvement. Given Sydney Airport's P/E ratio has declined from 41.6 to 28.8 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 prefer to invest with the flow of momentum, that might be a bad sign, but for a contrarian, it may signal opportunity.
Investors have an opportunity when market expectations about a stock are wrong. 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 visual report on analyst forecasts could hold the key to an excellent investment decision.
Of course you might be able to find a better stock than Sydney Airport. So you may wish to see this free collection of other companies that have grown earnings strongly.
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