It's really great to see that even after a strong run, Affle (India) (NSE:AFFLE) shares have been powering on, with a gain of 37% in the last thirty days. Longer term shareholders are no doubt thankful for the recovery in the share price, since it's pretty much flat for the year, even after the recent pop.
All else being equal, a sharp share price increase should make a stock less 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 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.
How Does Affle (India)'s P/E Ratio Compare To Its Peers?
We can tell from its P/E ratio of 67.81 that there is some investor optimism about Affle (India). You can see in the image below that the average P/E (13.1) for companies in the media industry is a lot lower than Affle (India)'s P/E.
That means that the market expects Affle (India) will outperform other companies in its industry. Shareholders are clearly optimistic, but the future is always uncertain. So investors 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. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. 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.
In the last year, Affle (India) grew EPS like Taylor Swift grew her fan base back in 2010; the 105% gain was both fast and well deserved. The cherry on top is that the five year growth rate was an impressive 90% per year. With that kind of growth rate we would generally expect a high P/E ratio.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
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. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
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 Affle (India)'s Balance Sheet Tell Us?
The extra options and safety that comes with Affle (India)'s ₹738m net cash position means that it deserves a higher P/E than it would if it had a lot of net debt.
The Verdict On Affle (India)'s P/E Ratio
Affle (India)'s P/E is 67.8 which suggests the market is more focussed on the future opportunity rather than the current level of earnings. The excess cash it carries is the gravy on top its fast EPS growth. To us, this is the sort of company that we would expect to carry an above average price tag (relative to earnings). What is very clear is that the market has become significantly more optimistic about Affle (India) over the last month, with the P/E ratio rising from 49.3 back then to 67.8 today. If you like to buy stocks that have recently impressed the market, then this one might be a candidate; but if you prefer to invest when there is 'blood in the streets', then you may feel the opportunity has passed.
Investors should be looking to buy stocks that the market is wrong about. 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. We don't have analyst forecasts, but you could get a better understanding of its growth by checking out this more detailed historical graph of earnings, revenue and cash flow.
Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.
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