Unfortunately for some shareholders, the MTU Aero Engines (ETR:MTX) share price has dived 55% in the last thirty days. That drop has capped off a tough year for shareholders, with the share price down 37% in that time.
All else being equal, a share price drop should make a stock more 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, 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 MTU Aero Engines Have A Relatively High Or Low P/E For Its Industry?
MTU Aero Engines's P/E of 13.52 indicates some degree of optimism towards the stock. You can see in the image below that the average P/E (11.9) for companies in the aerospace & defense industry is lower than MTU Aero Engines's P/E.
That means that the market expects MTU Aero Engines will outperform other companies in its industry. The market is optimistic about the future, but that doesn't guarantee future growth. So investors 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. 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.
MTU Aero Engines's earnings per share grew by 6.5% in the last twelve months. And it has bolstered its earnings per share by 19% per year over the last five 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. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.
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).
Is Debt Impacting MTU Aero Engines's P/E?
The extra options and safety that comes with MTU Aero Engines's €181m 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 MTU Aero Engines's P/E Ratio
MTU Aero Engines's P/E is 13.5 which is below average (15.2) in the DE market. Recent earnings growth wasn't bad. And the net cash position gives the company many options. So it's strange that the low P/E indicates low expectations. What can be absolutely certain is that the market has become significantly less optimistic about MTU Aero Engines over the last month, with the P/E ratio falling from 29.8 back then to 13.5 today. For those who prefer to invest with the flow of momentum, that might be a bad sign, but for a contrarian, it may signal opportunity.
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 visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.
You might be able to find a better buy than MTU Aero Engines. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
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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