To the annoyance of some shareholders,b&t folding stock

Rexnord

(

NYSE:RXN

) shares are down a considerable 31% in the last month. The recent drop has obliterated the annual return, with the share price now down 23% 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. 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 Rexnord

How Does Rexnord's P/E Ratio Compare To Its Peers?

We can tell from its P/E ratio of 12.02 that sentiment around Rexnord isn't particularly high. We can see in the image below that the average P/E (14.8) for companies in the machinery industry is higher than Rexnord's P/E.

NYSE:RXN Price Estimation Relative to Market April 2nd 2020

Rexnord'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

Generally speaking the rate of earnings growth has a profound impact on a company's P/E multiple. That's because companies that grow earnings per share quickly will rapidly increase the 'E' in the equation. And in that case, the P/E ratio itself will drop rather quickly. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.

Rexnord's earnings per share were pretty steady over the last year. But over the longer term (5 years) earnings per share have increased by 13%.

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

Story continues

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

Rexnord has net debt equal to 34% of its market cap. You'd want to be aware of this fact, but it doesn't bother us.

The Verdict On Rexnord's P/E Ratio

Rexnord's P/E is 12.0 which is about average (12.9) in the US market. When you consider the lack of EPS growth last year (along with some debt), it seems the market is optimistic about the future for the business. Given Rexnord's P/E ratio has declined from 17.4 to 12.0 in the last month, we know for sure that the market is significantly less confident about the business today, than it was back then. 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.

Investors have an opportunity when market expectations about a stock are wrong. 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 Rexnord

. 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

[email protected]

. 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.

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