Unfortunately for some shareholders, the Trustpower (NZSE:TPW) share price has dived 36% in the last thirty days. Even longer term holders have taken a real hit with the stock declining 29% in the last year.
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. 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.
How Does Trustpower's P/E Ratio Compare To Its Peers?
We can tell from its P/E ratio of 21.82 that sentiment around Trustpower isn't particularly high. If you look at the image below, you can see Trustpower has a lower P/E than the average (25.9) in the electric utilities industry classification.
Trustpower'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 Trustpower, 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
Generally speaking the rate of earnings growth has a profound impact on a company's P/E multiple. Earnings growth means that in the future the 'E' will be higher. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. Then, a lower P/E should attract more buyers, pushing the share price up.
Trustpower shrunk earnings per share by 34% over the last year. But over the longer term (3 years), earnings per share have increased by 7.6%. And it has shrunk its earnings per share by 13% per year over the last five years. This might lead to muted expectations.
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. In other words, it does not consider any debt or cash that the company may have on the balance sheet. 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 Trustpower's Debt Impact Its P/E Ratio?
Trustpower has net debt equal to 37% of its market cap. While that's enough to warrant consideration, it doesn't really concern us.
The Bottom Line On Trustpower's P/E Ratio
Trustpower has a P/E of 21.8. That's higher than the average in its market, which is 15.0. With a bit of debt, but a lack of recent growth, it's safe to say the market is expecting improved profit performance from the company, in the next few years. What can be absolutely certain is that the market has become significantly less optimistic about Trustpower over the last month, with the P/E ratio falling from 34.1 back then to 21.8 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.
When the market is wrong about a stock, it gives savvy investors an opportunity. 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.
Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E 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.
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