What Is CarGurus's (NASDAQ:CARG) P/E Ratio After Its Share Price Rocketed?
CarGurus (NASDAQ:CARG) shareholders are no doubt pleased to see that the share price has bounced 31% in the last month alone, although it is still down 14% over the last quarter. But shareholders may not all be feeling jubilant, since the share price is still down 33% in the last year.
Assuming no other changes, a sharply higher share price makes a stock less attractive to potential buyers. 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). The implication here is that deep value investors might steer clear when expectations of a company are too high. 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.
See our latest analysis for CarGurus
Does CarGurus Have A Relatively High Or Low P/E For Its Industry?
We can tell from its P/E ratio of 63.25 that there is some investor optimism about CarGurus. You can see in the image below that the average P/E (26.6) for companies in the interactive media and services industry is lower than CarGurus's P/E.
CarGurus's P/E tells us that market participants think the company will perform better than its industry peers, going forward. Clearly the market expects growth, but it isn't guaranteed. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.
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. When earnings grow, the 'E' increases, over time. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. Then, a lower P/E should attract more buyers, pushing the share price up.
CarGurus's earnings per share fell by 42% in the last twelve months.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
Don't forget that the P/E ratio considers market capitalization. So it won't reflect the advantage of cash, or disadvantage of debt. 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.
How Does CarGurus's Debt Impact Its P/E Ratio?
Since CarGurus holds net cash of US$156m, it can spend on growth, justifying a higher P/E ratio than otherwise.
The Bottom Line On CarGurus's P/E Ratio
With a P/E ratio of 63.3, CarGurus is expected to grow earnings very strongly in the years to come. The recent drop in earnings per share might keep value investors away, but the healthy balance sheet means the company retains the potential for future growth. If this growth fails to materialise, the current high P/E could prove to be temporary, as the share price falls. What we know for sure is that investors have become much more excited about CarGurus recently, since they have pushed its P/E ratio from 48.4 to 63.3 over the last month. 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 have an opportunity when market expectations about a stock are wrong. 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 visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.
You might be able to find a better buy than CarGurus. 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).
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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. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned. Thank you for reading.