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To the annoyance of some shareholders, Diadrom Holding (STO:DIAH) shares are down a considerable 46% in the last month. Indeed the recent decline has arguably caused some bitterness for shareholders who have held through the 44% 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. So, on certain occasions, long term focussed investors try to take advantage of pessimistic expectations to buy shares at a better price. 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 Diadrom Holding
How Does Diadrom Holding's P/E Ratio Compare To Its Peers?
Diadrom Holding's P/E of 7.31 indicates relatively low sentiment towards the stock. We can see in the image below that the average P/E (14.3) for companies in the it industry is higher than Diadrom Holding's P/E.
This suggests that market participants think Diadrom Holding will underperform other companies in its industry. 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. When earnings grow, the 'E' increases, over time. That means even if the current P/E is high, it will reduce over time if the share price stays flat. Then, a lower P/E should attract more buyers, pushing the share price up.
Most would be impressed by Diadrom Holding earnings growth of 19% in the last year. And its annual EPS growth rate over 3 years is 6.5%. This could arguably justify a relatively high P/E ratio. In contrast, EPS has decreased by 1.6%, annually, over 5 years.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. 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).