Connexion Telematics (ASX:CXZ) shares have continued recent momentum with a 50% gain in the last month alone. The 329% gain over the last year is certainly lovely to see, just like a wink and smile from your sweetheart.
Assuming no other changes, a sharply higher share price makes a stock less 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. The implication here is that deep value investors might steer clear when expectations of a company are too high. 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.
Does Connexion Telematics Have A Relatively High Or Low P/E For Its Industry?
Connexion Telematics's P/E of 52.91 indicates some degree of optimism towards the stock. The image below shows that Connexion Telematics has a higher P/E than the average (36.1) P/E for companies in the software industry.
Its relatively high P/E ratio indicates that Connexion Telematics 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 further research is always essential. I often monitor director buying and 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. 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. And as that P/E ratio drops, the company will look cheap, unless its share price increases.
Connexion Telematics saw earnings per share decrease by 23% last year.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
Don't forget that the P/E ratio considers market capitalization. That means it doesn't take debt or cash into account. 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).
How Does Connexion Telematics's Debt Impact Its P/E Ratio?
Connexion Telematics has net cash of AU$939k. That should lead to a higher P/E than if it did have debt, because its strong balance sheets gives it more options.
The Verdict On Connexion Telematics's P/E Ratio
Connexion Telematics trades on a P/E ratio of 52.9, which is above its market average of 18.5. The recent drop in earnings per share might keep value investors away, but the net cash position means the company has time to improve: and the high P/E suggests the market thinks it will. What we know for sure is that investors have become much more excited about Connexion Telematics recently, since they have pushed its P/E ratio from 35.3 to 52.9 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 should be looking to buy stocks that the market is wrong about. People often underestimate remarkable growth -- so investors can make money when fast growth is not fully appreciated. Although we don't have analyst forecasts shareholders might want to examine this detailed historical graph of earnings, revenue and cash flow.
But note: Connexion Telematics may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
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.
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.