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Do You Like Spectra Products Inc. (CVE:SSA) At This P/E Ratio?

Simply Wall St

Unfortunately for some shareholders, the Spectra Products (CVE:SSA) share price has dived in the last thirty days. Looking back over the last year, the stock has been a solid performer, with a gain of 11%.

Assuming no other changes, a sharply higher share price makes a stock less 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 some would prefer to hold off buying when there is a lot of optimism towards a stock. 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.

See our latest analysis for Spectra Products

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

Spectra Products's P/E of 8.45 indicates relatively low sentiment towards the stock. The image below shows that Spectra Products has a lower P/E than the average (14.6) P/E for companies in the auto components industry.

TSXV:SSA Price Estimation Relative to Market, February 5th 2020

Spectra Products'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. That means even if the current P/E is high, it will reduce over time if the share price stays flat. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.

Spectra Products increased earnings per share by a whopping 42% last year. And it has improved its earnings per share by 99% per year over the last three years. I'd therefore be a little surprised if its P/E ratio was not relatively high.

Remember: P/E Ratios Don't Consider The Balance Sheet

One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. So it won't reflect the advantage of cash, or disadvantage of debt. 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).

Spending on growth might be good or bad a few years later, but the point is that the P/E ratio does not account for the option (or lack thereof).

Spectra Products's Balance Sheet

Since Spectra Products holds net cash of CA$246k, it can spend on growth, justifying a higher P/E ratio than otherwise.

The Bottom Line On Spectra Products's P/E Ratio

Spectra Products's P/E is 8.5 which is below average (15.4) in the CA market. The net cash position gives plenty of options to the business, and the recent improvement in EPS is good to see. One might conclude that the market is a bit pessimistic, given the low P/E ratio. What can be absolutely certain is that the market has become more pessimistic about Spectra Products over the last month, with the P/E ratio falling from 8.5 back then to 8.5 today. For those who prefer invest in growth, this stock apparently offers limited promise, but the deep value investors may find the pessimism around this stock enticing.

Investors should be looking to buy stocks that the market is wrong about. 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. Although we don't have analyst forecasts you could get a better understanding of its growth by checking out this more detailed historical graph of earnings, revenue and cash flow.

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.