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Casa Systems (NASDAQ:CASA) shares have had a really impressive month, gaining 38%, after some slippage. But shareholders may not all be feeling jubilant, since the share price is still down 50% in the last year.
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 Casa Systems's P/E Ratio Compare To Its Peers?
Casa Systems has a P/E ratio of 31.79. As you can see below Casa Systems has a P/E ratio that is fairly close for the average for the communications industry, which is 32.7.
Its P/E ratio suggests that Casa Systems shareholders think that in the future it will perform about the same as other companies in its industry classification. The company could surprise by performing better than average, in the future. I would further inform my view by checking insider buying and selling., among other things.
How Growth Rates Impact P/E Ratios
Companies that shrink earnings per share quickly will rapidly decrease the 'E' in the equation. 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.
Casa Systems's earnings per share fell by 74% in the last twelve months. And over the longer term (5 years) earnings per share have decreased 21% annually. This could justify a pessimistic P/E.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. That means it doesn't take debt or cash into account. 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.
How Does Casa Systems's Debt Impact Its P/E Ratio?
Net debt is 26% of Casa Systems's market cap. While that's enough to warrant consideration, it doesn't really concern us.
The Verdict On Casa Systems's P/E Ratio
Casa Systems trades on a P/E ratio of 31.8, which is above its market average of 18.0. With some debt but no EPS growth last year, the market has high expectations of future profits. What is very clear is that the market has become significantly more optimistic about Casa Systems over the last month, with the P/E ratio rising from 23.1 back then to 31.8 today. For those who prefer to invest with the flow of momentum, that might mean it's time to put the stock on a watchlist, or research it. But the contrarian may see it as a missed opportunity.
Investors should be looking to buy stocks that the market is wrong about. 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 Casa Systems. 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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If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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. Thank you for reading.