How Does Diamond Hill Investment Group's (NASDAQ:DHIL) P/E Compare To Its Industry, After The Share Price Drop?

To the annoyance of some shareholders, Diamond Hill Investment Group (NASDAQ:DHIL) shares are down a considerable 32% in the last month. That drop has capped off a tough year for shareholders, with the share price down 35% in that time.

Assuming nothing else has changed, a lower share price makes a stock more 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 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 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.

Check out our latest analysis for Diamond Hill Investment Group

How Does Diamond Hill Investment Group's P/E Ratio Compare To Its Peers?

Diamond Hill Investment Group's P/E of 5.70 indicates relatively low sentiment towards the stock. We can see in the image below that the average P/E (28.9) for companies in the capital markets industry is higher than Diamond Hill Investment Group's P/E.

Diamond Hill Investment Group's P/E tells us that market participants think it will not fare as well as its peers in the same industry. 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

P/E ratios primarily reflect market expectations around earnings growth rates. 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. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.

It's great to see that Diamond Hill Investment Group grew EPS by 19% in the last year. And earnings per share have improved by 10% annually, over the last five years. With that performance, you might expect an above average P/E ratio.

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. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.

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 Diamond Hill Investment Group's P/E?

Diamond Hill Investment Group has net cash of US$93m. This is fairly high at 33% of its market capitalization. That might mean balance sheet strength is important to the business, but should also help push the P/E a bit higher than it would otherwise be.

The Bottom Line On Diamond Hill Investment Group's P/E Ratio

Diamond Hill Investment Group trades on a P/E ratio of 5.7, which is below the US market average of 13.4. Not only should the net cash position reduce risk, but the recent growth has been impressive. The relatively low P/E ratio implies the market is pessimistic. What can be absolutely certain is that the market has become more pessimistic about Diamond Hill Investment Group over the last month, with the P/E ratio falling from 8.3 back then to 5.7 today. For those who prefer to invest with the flow of momentum, that might be a bad sign, but for deep value investors this stock might justify some research.

Investors have an opportunity when market expectations about a stock are wrong. 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. We don't have analyst forecasts, but you could get a better understanding of its growth by checking out this more detailed historical graph of earnings, revenue and cash flow.

But note: Diamond Hill Investment Group 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 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.