Unfortunately for some shareholders, the Advanced Energy Industries (NASDAQ:AEIS) share price has dived 30% in the last thirty days. The recent drop has obliterated the annual return, with the share price now down 21% over that longer period.

All else being equal, a share price drop should make a stock more attractive to potential investors. 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. 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). 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.

View our latest analysis for Advanced Energy Industries

Does Advanced Energy Industries Have A Relatively High Or Low P/E For Its Industry?

We can tell from its P/E ratio of 29.20 that there is some investor optimism about Advanced Energy Industries. You can see in the image below that the average P/E (25.2) for companies in the semiconductor industry is lower than Advanced Energy Industries's P/E.

Its relatively high P/E ratio indicates that Advanced Energy Industries shareholders think it will perform better than other companies in its industry classification. Shareholders are clearly optimistic, but the future is always uncertain. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.

How Growth Rates Impact P/E Ratios

When earnings fall, the 'E' decreases, over time. That means unless the share price falls, the P/E will increase in a few years. So while a stock may look cheap based on past earnings, it could be expensive based on future earnings.

Advanced Energy Industries shrunk earnings per share by 61% over the last year. And EPS is down 3.0% a year, over the last 5 years. This could justify a pessimistic P/E.

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. 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.

Such spending might be good or bad, overall, but the key point here is that you need to look at debt to understand the P/E ratio in context.

Advanced Energy Industries's Balance Sheet

The extra options and safety that comes with Advanced Energy Industries's US$10m 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 Advanced Energy Industries's P/E Ratio

Advanced Energy Industries's P/E is 29.2 which is above average (12.4) in its market. The recent drop in earnings per share might keep value investors away, but the healthy balance sheet means the company retains the potential for future growth. If this growth fails to materialise, the current high P/E could prove to be temporary, as the share price falls. Given Advanced Energy Industries's P/E ratio has declined from 41.9 to 29.2 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.

When the market is wrong about a stock, it gives savvy investors an opportunity. 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 visual report on analyst forecasts could hold the key to an excellent investment decision.

Of course you might be able to find a better stock than Advanced Energy Industries. 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 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.