How Does PolyOne's (NYSE:POL) P/E Compare To Its Industry, After The Share Price Drop?

To the annoyance of some shareholders, PolyOne (NYSE:POL) shares are down a considerable 31% in the last month. The recent drop has obliterated the annual return, with the share price now down 27% over that longer period.

All else being equal, a share price drop should make a stock more attractive to potential investors. 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, 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 PolyOne

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

We can tell from its P/E ratio of 24.95 that there is some investor optimism about PolyOne. You can see in the image below that the average P/E (20.3) for companies in the chemicals industry is lower than PolyOne's P/E.

That means that the market expects PolyOne will outperform other companies in its industry. The market is optimistic about the future, but that doesn't guarantee future growth. So investors should delve deeper. I like to check if company insiders have been buying or selling.

How Growth Rates Impact P/E Ratios

If earnings fall then in the future the 'E' will be lower. Therefore, even if you pay a low multiple of earnings now, that multiple will become higher in the future. A higher P/E should indicate the stock is expensive relative to others -- and that may encourage shareholders to sell.

PolyOne saw earnings per share decrease by 11% last year. But it has grown its earnings per share by 3.0% per year over the last five years. And over the longer term (3 years) earnings per share have decreased 21% annually. This might lead to low expectations.

Don't Forget: The P/E Does Not Account For Debt or Bank Deposits

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. 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.

Such spending might be good or bad, overall, but the key point here is that you need to look at debt to understand the P/E ratio in context.

So What Does PolyOne's Balance Sheet Tell Us?

Net debt totals 16% of PolyOne's market cap. This could bring some additional risk, and reduce the number of investment options for management; worth remembering if you compare its P/E to businesses without debt.

The Verdict On PolyOne's P/E Ratio

PolyOne has a P/E of 24.9. That's higher than the average in its market, which is 16.9. With modest debt but no EPS growth in the last year, it's fair to say the P/E implies some optimism about future earnings, from the market. What can be absolutely certain is that the market has become significantly less optimistic about PolyOne over the last month, with the P/E ratio falling from 36.4 back then to 24.9 today. For those who prefer to invest with the flow of momentum, that might be a bad sign, but for a contrarian, it may signal opportunity.

When the market is wrong about a stock, it gives savvy investors an opportunity. As value investor Benjamin Graham famously said, 'In the short run, the market is a voting machine but in the long run, it is a weighing machine. 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.

Of course you might be able to find a better stock than PolyOne. So you may wish to see this free collection of other companies that have grown earnings strongly.

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.

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