What Is Morgan Advanced Materials's (LON:MGAM) P/E Ratio After Its Share Price Tanked?

To the annoyance of some shareholders, Morgan Advanced Materials (LON:MGAM) shares are down a considerable 33% in the last month. Even longer term holders have taken a real hit with the stock declining 25% in the last year.

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.

Check out our latest analysis for Morgan Advanced Materials

How Does Morgan Advanced Materials's P/E Ratio Compare To Its Peers?

Morgan Advanced Materials's P/E of 7.57 indicates relatively low sentiment towards the stock. We can see in the image below that the average P/E (12.5) for companies in the machinery industry is higher than Morgan Advanced Materials's P/E.

This suggests that market participants think Morgan Advanced Materials will underperform other companies in its 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. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. 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.

It's nice to see that Morgan Advanced Materials grew EPS by a stonking 26% in the last year. And its annual EPS growth rate over 5 years is 56%. So we'd generally expect it to have a relatively high P/E ratio.

Remember: P/E Ratios Don't Consider The Balance Sheet

Don't forget that the P/E ratio considers market capitalization. So it won't reflect the advantage of cash, or disadvantage of debt. 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).

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.

So What Does Morgan Advanced Materials's Balance Sheet Tell Us?

Morgan Advanced Materials has net debt equal to 29% of its market cap. While that's enough to warrant consideration, it doesn't really concern us.

The Bottom Line On Morgan Advanced Materials's P/E Ratio

Morgan Advanced Materials trades on a P/E ratio of 7.6, which is below the GB market average of 12.5. The company does have a little debt, and EPS growth was good last year. If the company can continue to grow earnings, then the current P/E may be unjustifiably low. Given Morgan Advanced Materials's P/E ratio has declined from 11.4 to 7.6 in the last month, we know for sure that the market is more worried about the business today, than it was back then. For those who prefer invest in growth, this stock apparently offers limited promise, but the deep value investors may find the pessimism around this stock enticing.

Investors have an opportunity when market expectations about a stock are wrong. 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: Morgan Advanced Materials 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.