Unfortunately for some shareholders, the Alfa Financial Software Holdings (LON:ALFA) share price has dived 36% in the last thirty days. Given the 65% drop over the last year, some shareholders might be worried that they have become bagholders. For those wondering, a bagholder is someone who keeps holding a losing stock indefinitely, without taking the time to consider its prospects carefully, going forward.

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. One way to gauge market expectations of a stock 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 Alfa Financial Software Holdings

How Does Alfa Financial Software Holdings's P/E Ratio Compare To Its Peers?

We can tell from its P/E ratio of 10.82 that sentiment around Alfa Financial Software Holdings isn't particularly high. We can see in the image below that the average P/E (29.3) for companies in the software industry is higher than Alfa Financial Software Holdings's P/E.

This suggests that market participants think Alfa Financial Software Holdings will underperform other companies in its industry. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. 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

When earnings fall, the 'E' decreases, over time. That means even if the current P/E is low, it will increase over time if the share price stays flat. Then, a higher P/E might scare off shareholders, pushing the share price down.

Alfa Financial Software Holdings's earnings per share fell by 32% in the last twelve months. And it has shrunk its earnings per share by 60% per year over the last five years. This could justify a pessimistic P/E.

A Limitation: P/E Ratios Ignore Debt and Cash In The Bank

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