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Unfortunately for some shareholders, the Sandfire Resources (ASX:SFR) share price has dived 34% in the last thirty days. Indeed the recent decline has arguably caused some bitterness for shareholders who have held through the 50% drop over twelve months.
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. 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.
View our latest analysis for Sandfire Resources
Does Sandfire Resources Have A Relatively High Or Low P/E For Its Industry?
We can tell from its P/E ratio of 6.23 that sentiment around Sandfire Resources isn't particularly high. If you look at the image below, you can see Sandfire Resources has a lower P/E than the average (9.7) in the metals and mining industry classification.
Sandfire Resources's P/E tells us that market participants think it will not fare as well as its peers in the same industry. Since the market seems unimpressed with Sandfire Resources, it's quite possible it could surprise on the upside. 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. When earnings grow, the 'E' increases, over time. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. Then, a lower P/E should attract more buyers, pushing the share price up.
Sandfire Resources shrunk earnings per share by 23% over the last year. But it has grown its earnings per share by 2.5% per year over the last five years.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. Thus, the metric does not reflect cash or debt held by the company. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
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.