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What Is Data#3's (ASX:DTL) P/E Ratio After Its Share Price Rocketed?

Simply Wall St

Data#3 (ASX:DTL) shareholders are no doubt pleased to see that the share price has bounced 35% in the last month alone, although it is still down 9.8% over the last quarter. Zooming out, the annual gain of 108% knocks our socks off.

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. So some would prefer to hold off buying when there is a lot of optimism towards a stock. 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.

View our latest analysis for Data#3

How Does Data#3's P/E Ratio Compare To Its Peers?

We can tell from its P/E ratio of 28.23 that there is some investor optimism about Data#3. You can see in the image below that the average P/E (24.1) for companies in the it industry is lower than Data#3's P/E.

ASX:DTL Price Estimation Relative to Market April 15th 2020
ASX:DTL Price Estimation Relative to Market April 15th 2020

Data#3'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

Earnings growth rates have a big influence on P/E ratios. That's because companies that grow earnings per share quickly will rapidly increase the 'E' in the equation. That means even if the current P/E is high, it will reduce over time if the share price stays flat. And as that P/E ratio drops, the company will look cheap, unless its share price increases.

Most would be impressed by Data#3 earnings growth of 18% in the last year. And it has bolstered its earnings per share by 19% per year over the last five years. This could arguably justify a relatively 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. So it won't reflect the advantage of cash, or disadvantage of debt. 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).

Data#3's Balance Sheet

Data#3 has net cash of AU$23m. 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 Data#3's P/E Ratio

Data#3 has a P/E of 28.2. That's higher than the average in its market, which is 14.4. Its strong balance sheet gives the company plenty of resources for extra growth, and it has already proven it can grow. Therefore it seems reasonable that the market would have relatively high expectations of the company What is very clear is that the market has become significantly more optimistic about Data#3 over the last month, with the P/E ratio rising from 20.9 back then to 28.2 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 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 Data#3. 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).

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. 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.