Unfortunately for some shareholders, the CanWel Building Materials Group (TSE:CWX) share price has dived 35% 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. One way to gauge market expectations of a stock 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.
Does CanWel Building Materials Group Have A Relatively High Or Low P/E For Its Industry?
We can tell from its P/E ratio of 20.01 that there is some investor optimism about CanWel Building Materials Group. The image below shows that CanWel Building Materials Group has a higher P/E than the average (10.3) P/E for companies in the trade distributors industry.
CanWel Building Materials Group'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
If earnings fall then in the future the 'E' will be lower. That means unless the share price falls, the P/E will increase in a few years. A higher P/E should indicate the stock is expensive relative to others -- and that may encourage shareholders to sell.
CanWel Building Materials Group's earnings per share fell by 60% in the last twelve months. And over the longer term (5 years) earnings per share have decreased 16% annually. This growth rate might warrant a below average P/E ratio.
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. Theoretically, a business can improve its earnings (and produce a lower P/E in the future) by investing in growth. That means taking on debt (or spending its cash).
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.
CanWel Building Materials Group's Balance Sheet
CanWel Building Materials Group has net debt worth a very significant 110% of its market capitalization. This is a relatively high level of debt, so the stock probably deserves a relatively low P/E ratio. Keep that in mind when comparing it to other companies.
The Verdict On CanWel Building Materials Group's P/E Ratio
CanWel Building Materials Group trades on a P/E ratio of 20.0, which is above its market average of 11.6. With significant debt and no EPS growth last year, shareholders are betting on an improvement in earnings from the company. What can be absolutely certain is that the market has become significantly less optimistic about CanWel Building Materials Group over the last month, with the P/E ratio falling from 31.0 back then to 20.0 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.
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 report on the analyst consensus forecasts could help you make a master move on this stock.
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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