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Bombay Burmah Trading Corporation (NSE:BBTC) shareholders are no doubt pleased to see that the share price has had a great month, posting a 39% gain, recovering from prior weakness. But shareholders may not all be feeling jubilant, since the share price is still down 34% in the last year.
All else being equal, a sharp share price increase should make a stock less 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. 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.
Check out our latest analysis for Bombay Burmah Trading Corporation
Does Bombay Burmah Trading Corporation Have A Relatively High Or Low P/E For Its Industry?
We can tell from its P/E ratio of 8.08 that sentiment around Bombay Burmah Trading Corporation isn't particularly high. If you look at the image below, you can see Bombay Burmah Trading Corporation has a lower P/E than the average (14.6) in the food industry classification.
Its relatively low P/E ratio indicates that Bombay Burmah Trading Corporation 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. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.
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 unless the share price increases, the P/E will reduce in a few years. Then, a lower P/E should attract more buyers, pushing the share price up.
In the last year, Bombay Burmah Trading Corporation grew EPS like Taylor Swift grew her fan base back in 2010; the 120% gain was both fast and well deserved. The cherry on top is that the five year growth rate was an impressive 35% per year. With that kind of growth rate we would generally expect a high P/E ratio.
Remember: P/E Ratios Don't Consider The Balance Sheet
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. That means it doesn't take debt or cash into account. 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).