ON Semiconductor (NASDAQ:ON) shareholders are no doubt pleased to see that the share price has bounced 58% in the last month alone, although it is still down 47% over the last quarter. But shareholders may not all be feeling jubilant, since the share price is still down 41% in the last year.
Assuming no other changes, a sharply higher share price makes a stock less 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). So some would prefer to hold off buying when there is a lot of optimism towards a stock. 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.
Does ON Semiconductor Have A Relatively High Or Low P/E For Its Industry?
ON Semiconductor's P/E of 25.88 indicates relatively low sentiment towards the stock. If you look at the image below, you can see ON Semiconductor has a lower P/E than the average (28.9) in the semiconductor industry classification.
ON Semiconductor's P/E tells us that market participants think it will not fare as well as its peers in the same industry. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. You should delve deeper. I like to check if company insiders have been buying or selling.
How Growth Rates Impact P/E Ratios
Earnings growth rates have a big influence on P/E ratios. When earnings grow, the 'E' increases, over time. And in that case, the P/E ratio itself will drop rather quickly. Then, a lower P/E should attract more buyers, pushing the share price up.
ON Semiconductor's earnings per share fell by 65% in the last twelve months. But it has grown its earnings per share by 3.6% per year over the last five years.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
The 'Price' in P/E reflects the market capitalization of the company. 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).
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.
ON Semiconductor's Balance Sheet
ON Semiconductor has net debt equal to 50% of its market cap. While that's enough to warrant consideration, it doesn't really concern us.
The Verdict On ON Semiconductor's P/E Ratio
ON Semiconductor's P/E is 25.9 which is above average (13.2) in its market. With some debt but no EPS growth last year, the market has high expectations of future profits. What is very clear is that the market has become significantly more optimistic about ON Semiconductor over the last month, with the P/E ratio rising from 16.4 back then to 25.9 today. For those who prefer to invest with the flow of momentum, that might mean it's time to put the stock on a watchlist, or research it. But the contrarian may see it as a missed opportunity.
Investors should be looking to buy stocks that the market is wrong about. People often underestimate remarkable growth -- so investors can make money when fast growth is not fully appreciated. So this free visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.
But note: ON Semiconductor may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.
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