Unfortunately for some shareholders, the CF Industries Holdings (NYSE:CF) share price has dived 31% in the last thirty days. Indeed the recent decline has arguably caused some bitterness for shareholders who have held through the 39% drop over twelve months.
Assuming nothing else has changed, a lower share price makes a stock more 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). The implication here is that long term investors have an opportunity when expectations of a company are too low. 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 implies that investors have high expectations of what a company can achieve compared to a company with a low P/E ratio.
Does CF Industries Holdings Have A Relatively High Or Low P/E For Its Industry?
We can tell from its P/E ratio of 11.41 that sentiment around CF Industries Holdings isn't particularly high. If you look at the image below, you can see CF Industries Holdings has a lower P/E than the average (15.0) in the chemicals industry classification.
Its relatively low P/E ratio indicates that CF Industries Holdings shareholders think it will struggle to do as well as other companies in its industry classification. 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
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. And in that case, the P/E ratio itself will drop rather quickly. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
CF Industries Holdings's earnings made like a rocket, taking off 80% last year. Unfortunately, earnings per share are down 16% a year, over 5 years.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. So it won't reflect the advantage of cash, or disadvantage of debt. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
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.
Is Debt Impacting CF Industries Holdings's P/E?
CF Industries Holdings's net debt is 66% of its market cap. If you want to compare its P/E ratio to other companies, you should absolutely keep in mind it has significant borrowings.
The Verdict On CF Industries Holdings's P/E Ratio
CF Industries Holdings trades on a P/E ratio of 11.4, which is below the US market average of 13.0. The company may have significant debt, but EPS growth was good last year. If the company can continue to grow earnings, then the current P/E may be unjustifiably low. Given CF Industries Holdings's P/E ratio has declined from 16.5 to 11.4 in the last month, we know for sure that the market is significantly less confident about the business today, than it was back then. For those who don't like to trade against momentum, that could be a warning sign, but a contrarian investor might want to take a closer look.
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. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.
But note: CF Industries Holdings 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).
If you spot an error that warrants correction, please contact the editor at email@example.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.
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