Those holding Barratt Developments (LON:BDEV) shares must be pleased that the share price has rebounded 33% in the last thirty days. But unfortunately, the stock is still down by 39% over a quarter. But shareholders may not all be feeling jubilant, since the share price is still down 21% 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 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 Barratt Developments's P/E Ratio Compare To Its Peers?
Barratt Developments's P/E of 6.54 indicates relatively low sentiment towards the stock. We can see in the image below that the average P/E (8.0) for companies in the consumer durables industry is higher than Barratt Developments's P/E.
Its relatively low P/E ratio indicates that Barratt Developments shareholders think it will struggle to do as well as other companies in its industry classification. 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
Earnings growth rates have a big influence on P/E ratios. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. 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.
Barratt Developments increased earnings per share by 3.0% last year. And it has bolstered its earnings per share by 14% per year over the last five years.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
Don't forget that the P/E ratio considers market capitalization. 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).
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 Barratt Developments's Debt Impact Its P/E Ratio?
The extra options and safety that comes with Barratt Developments's UK£427m net cash position means that it deserves a higher P/E than it would if it had a lot of net debt.
The Verdict On Barratt Developments's P/E Ratio
Barratt Developments's P/E is 6.5 which is below average (13.5) in the GB market. Recent earnings growth wasn't bad. Also positive, the relatively strong balance sheet will allow for investment in growth. In contrast, the P/E indicates shareholders doubt that will happen! What is very clear is that the market has become less pessimistic about Barratt Developments over the last month, with the P/E ratio rising from 4.9 back then to 6.5 today. If you like to buy stocks that could be turnaround opportunities, then this one might be a candidate; but if you're more sensitive to price, then you may feel the opportunity has passed.
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 report on the analyst consensus forecasts could help you make a master move on this stock.
Of course you might be able to find a better stock than Barratt Developments. So you may wish to see this free collection of other companies that have grown earnings strongly.
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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