Warrior Met Coal (NYSE:HCC) shareholders are no doubt pleased to see that the share price has bounced 40% in the last month alone, although it is still down 16% over the last quarter. But shareholders may not all be feeling jubilant, since the share price is still down 47% in the last year.
Assuming no other changes, a sharply higher share price makes a stock less attractive to potential buyers. 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. The implication here is that deep value investors might steer clear when expectations of a company are too high. 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). Investors have optimistic expectations of companies with higher P/E ratios, compared to companies with lower P/E ratios.
How Does Warrior Met Coal's P/E Ratio Compare To Its Peers?
We can tell from its P/E ratio of 3.38 that sentiment around Warrior Met Coal isn't particularly high. We can see in the image below that the average P/E (8.3) for companies in the metals and mining industry is higher than Warrior Met Coal's P/E.
Warrior Met Coal's P/E tells us that market participants think it will not fare as well as its peers in the same industry. Many investors like to buy stocks when the market is pessimistic about their prospects. 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
Probably the most important factor in determining what P/E a company trades on is the earnings growth. Earnings growth means that in the future the 'E' will be higher. That means even if the current P/E is high, it will reduce over time if the share price stays flat. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
Warrior Met Coal saw earnings per share decrease by 65% last year. But it has grown its earnings per share by 55% per year over the last three years.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. 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).
While growth expenditure doesn't always pay off, the point is that it is a good option to have; but one that the P/E ratio ignores.
How Does Warrior Met Coal's Debt Impact Its P/E Ratio?
Net debt totals 20% of Warrior Met Coal's market cap. It would probably deserve a higher P/E ratio if it was net cash, since it would have more options for growth.
The Bottom Line On Warrior Met Coal's P/E Ratio
Warrior Met Coal trades on a P/E ratio of 3.4, which is below the US market average of 15.1. With only modest debt, it's likely the lack of EPS growth at least partially explains the pessimism implied by the P/E ratio. What is very clear is that the market has become less pessimistic about Warrior Met Coal over the last month, with the P/E ratio rising from 2.4 back then to 3.4 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.
Investors should be looking to buy stocks that the market is wrong about. As value investor Benjamin Graham famously said, 'In the short run, the market is a voting machine but in the long run, it is a weighing machine. 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.
But note: Warrior Met Coal may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
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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. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned. Thank you for reading.