Those holding Synlait Milk (NZSE:SML) shares must be pleased that the share price has rebounded 40% in the last thirty days. But unfortunately, the stock is still down by 19% over a quarter. But shareholders may not all be feeling jubilant, since the share price is still down 32% in the last year.
All else being equal, a sharp share price increase should make a stock less attractive to potential investors. 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 some would prefer to hold off buying when there is a lot of optimism towards a stock. 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 implies that investors have high expectations of what a company can achieve compared to a company with a low P/E ratio.
How Does Synlait Milk's P/E Ratio Compare To Its Peers?
We can tell from its P/E ratio of 18.40 that there is some investor optimism about Synlait Milk. The image below shows that Synlait Milk has a higher P/E than the average (15.8) P/E for companies in the food industry.
Synlait Milk'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 always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.
How Growth Rates Impact P/E Ratios
P/E ratios primarily reflect market expectations around earnings growth rates. That's because companies that grow earnings per share quickly will rapidly increase the 'E' in the equation. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
Synlait Milk maintained roughly steady earnings over the last twelve months. But over the longer term (5 years) earnings per share have increased by 123%.
Remember: P/E Ratios Don't Consider The Balance Sheet
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. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.
Such expenditure might be good or bad, in the long term, but the point here is that the balance sheet is not reflected by this ratio.
Synlait Milk's Balance Sheet
Net debt is 35% of Synlait Milk's market cap. While that's enough to warrant consideration, it doesn't really concern us.
The Bottom Line On Synlait Milk's P/E Ratio
Synlait Milk's P/E is 18.4 which is above average (15.8) in its market. With debt at prudent levels and improving earnings, it's fair to say the market expects steady progress in the future. What we know for sure is that investors have become much more excited about Synlait Milk recently, since they have pushed its P/E ratio from 13.1 to 18.4 over the last month. For those who prefer to invest with the flow of momentum, that might mean it's time to put the stock on a watchlist, or research it. But the contrarian may see it as a missed opportunity.
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 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 email@example.com. 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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