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A Sliding Share Price Has Us Looking At Meritor, Inc.'s (NYSE:MTOR) P/E Ratio

Unfortunately for some shareholders, the Meritor (NYSE:MTOR) share price has dived 51% in the last thirty days. Indeed the recent decline has arguably caused some bitterness for shareholders who have held through the 38% drop over twelve months.

All else being equal, a share price drop should make a stock more attractive to potential investors. While the market sentiment towards a stock is very changeable, in the long run, the share price will tend to move in the same direction as earnings per share. 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 implies that investors have high expectations of what a company can achieve compared to a company with a low P/E ratio.

See our latest analysis for Meritor

How Does Meritor's P/E Ratio Compare To Its Peers?

We can tell from its P/E ratio of 4.28 that sentiment around Meritor isn't particularly high. The image below shows that Meritor has a lower P/E than the average (12.6) P/E for companies in the machinery industry.

NYSE:MTOR Price Estimation Relative to Market, March 24th 2020
NYSE:MTOR Price Estimation Relative to Market, March 24th 2020

Its relatively low P/E ratio indicates that Meritor shareholders think it will struggle to do as well as other companies in its industry classification. Since the market seems unimpressed with Meritor, it's quite possible it could surprise on the upside. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and selling.

How Growth Rates Impact P/E Ratios

Companies that shrink earnings per share quickly will rapidly decrease the 'E' in the equation. That means even if the current P/E is low, it will increase over time if the share price stays flat. A higher P/E should indicate the stock is expensive relative to others -- and that may encourage shareholders to sell.

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Meritor saw earnings per share improve by 3.5% last year. But earnings per share are down 23% per year over the last three years.

Don't Forget: The P/E Does Not Account For Debt or Bank Deposits

One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. Thus, the metric does not reflect cash or debt held by the company. 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 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.

How Does Meritor's Debt Impact Its P/E Ratio?

Meritor's net debt is considerable, at 107% of its market cap. 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 Meritor's P/E Ratio

Meritor's P/E is 4.3 which is below average (11.5) in the US market. It's good to see EPS growth in the last 12 months, but the debt on the balance sheet might be muting expectations. Given Meritor's P/E ratio has declined from 8.8 to 4.3 in the last month, we know for sure that the market is more worried 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 deep value investors this stock might justify some research.

When the market is wrong about a stock, it gives savvy investors an opportunity. If the reality for a company is not as bad as the P/E ratio indicates, then the share price should increase as the market realizes this. 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 editorial-team@simplywallst.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.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.