Unfortunately for some shareholders, the Base Resources (ASX:BSE) share price has dived 32% in the last thirty days. That drop has capped off a tough year for shareholders, with the share price down 42% in that time.
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.
How Does Base Resources's P/E Ratio Compare To Its Peers?
We can tell from its P/E ratio of 4.20 that sentiment around Base Resources isn't particularly high. If you look at the image below, you can see Base Resources has a lower P/E than the average (9.7) in the metals and mining industry classification.
Its relatively low P/E ratio indicates that Base Resources shareholders think it will struggle to do as well as other companies in its industry classification. Since the market seems unimpressed with Base Resources, it's quite possible it could surprise on the upside. 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
Earnings growth rates have a big influence on P/E ratios. Earnings growth means that in the future the 'E' will be higher. And in that case, the P/E ratio itself will drop rather quickly. And as that P/E ratio drops, the company will look cheap, unless its share price increases.
Base Resources's earnings per share fell by 14% in the last twelve months.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. In other words, it does not consider any debt or cash that the company may have on the balance sheet. The exact same company would hypothetically deserve a higher P/E ratio if it had a strong balance sheet, than if it had a weak one with lots of debt, because a cashed up company can spend on growth.
While growth expenditure doesn't always pay off, the point is that it is a good option to have; but one that the P/E ratio ignores.
How Does Base Resources's Debt Impact Its P/E Ratio?
Base Resources has net cash of US$33m. This is fairly high at 23% of its market capitalization. That might mean balance sheet strength is important to the business, but should also help push the P/E a bit higher than it would otherwise be.
The Bottom Line On Base Resources's P/E Ratio
Base Resources has a P/E of 4.2. That's below the average in the AU market, which is 15.9. The recent drop in earnings per share would almost certainly temper expectations, the relatively strong balance sheet will allow the company time to invest in growth. If it achieves that, then there's real potential that the low P/E could eventually indicate undervaluation. What can be absolutely certain is that the market has become more pessimistic about Base Resources over the last month, with the P/E ratio falling from 6.2 back then to 4.2 today. For those who prefer to invest with the flow of momentum, that might be a bad sign, but for deep value investors this stock might justify some research.
Investors have an opportunity when market expectations about a stock are wrong. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. So this free report on the analyst consensus forecasts could help you make a master move on this stock.
Of course you might be able to find a better stock than Base Resources. So you may wish to see this free collection of other companies that have grown earnings strongly.
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