How Does ALS's (ASX:ALQ) P/E Compare To Its Industry, After The Share Price Drop?

To the annoyance of some shareholders, ALS (ASX:ALQ) shares are down a considerable 33% in the last month. That drop has capped off a tough year for shareholders, with the share price down 30% in that time.

Assuming nothing else has changed, a lower share price makes a stock more attractive to potential buyers. 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). Investors have optimistic expectations of companies with higher P/E ratios, compared to companies with lower P/E ratios.

Check out our latest analysis for ALS

Does ALS Have A Relatively High Or Low P/E For Its Industry?

ALS's P/E of 16.14 indicates some degree of optimism towards the stock. The image below shows that ALS has a higher P/E than the average (11.5) P/E for companies in the professional services industry.

Its relatively high P/E ratio indicates that ALS shareholders think it will perform better than other companies in its industry classification. Shareholders are clearly optimistic, but the future is always uncertain. So further research is always essential. I often monitor director buying and selling.

How Growth Rates Impact P/E Ratios

P/E ratios primarily reflect market expectations around earnings growth rates. That's because companies that grow earnings per share quickly will rapidly increase the 'E' in the equation. That means even if the current P/E is high, it will reduce over time if the share price stays flat. And as that P/E ratio drops, the company will look cheap, unless its share price increases.

It's great to see that ALS grew EPS by 13% in the last year. And earnings per share have improved by 3.5% annually, over the last five years. So one might expect an above average P/E ratio.

Remember: P/E Ratios Don't Consider The Balance Sheet

One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. 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.

Spending on growth might be good or bad a few years later, but the point is that the P/E ratio does not account for the option (or lack thereof).

How Does ALS's Debt Impact Its P/E Ratio?

ALS's net debt equates to 26% of its market capitalization. You'd want to be aware of this fact, but it doesn't bother us.

The Bottom Line On ALS's P/E Ratio

ALS trades on a P/E ratio of 16.1, which is above its market average of 12.9. The company is not overly constrained by its modest debt levels, and its recent EPS growth very solid. So on this analysis it seems reasonable that its P/E ratio is above average. What can be absolutely certain is that the market has become significantly less optimistic about ALS over the last month, with the P/E ratio falling from 24.3 back then to 16.1 today. For those who don't like to trade against momentum, that could be a warning sign, but a contrarian investor might want to take a closer look.

When the market is wrong about a stock, it gives savvy investors an opportunity. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.

You might be able to find a better buy than ALS. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. 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.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.