A Sliding Share Price Has Us Looking At DWF Group plc's (LON:DWF) P/E Ratio

Unfortunately for some shareholders, the DWF Group (LON:DWF) share price has dived 34% in the last thirty days. The recent drop has obliterated the annual return, with the share price now down 26% over that longer period.

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. One way to gauge market expectations of a stock 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.

See our latest analysis for DWF Group

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

DWF Group's P/E of 23.73 indicates some degree of optimism towards the stock. The image below shows that DWF Group has a higher P/E than the average (14.8) P/E for companies in the professional services industry.

Its relatively high P/E ratio indicates that DWF Group shareholders think it will perform better than other companies in its industry classification. 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

Earnings growth rates have a big influence on P/E ratios. That's because companies that grow earnings per share quickly will rapidly increase the 'E' in the equation. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.

It's nice to see that DWF Group grew EPS by a stonking 48% in the last year.

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

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

So What Does DWF Group's Balance Sheet Tell Us?

Net debt totals 19% of DWF Group's market cap. It would probably deserve a higher P/E ratio if it was net cash, since it would have more options for growth.

The Verdict On DWF Group's P/E Ratio

DWF Group trades on a P/E ratio of 23.7, which is above its market average of 12.5. Its debt levels do not imperil its balance sheet and its EPS growth is very healthy indeed. So on this analysis a high P/E ratio seems reasonable. What can be absolutely certain is that the market has become significantly less optimistic about DWF Group over the last month, with the P/E ratio falling from 36.2 back then to 23.7 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 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 DWF Group. 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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