Those holding Advance NanoTek (ASX:ANO) shares must be pleased that the share price has rebounded 34% in the last thirty days. But unfortunately, the stock is still down by 7.0% over a quarter. Zooming out, the stock's 483% gain in the last year is certainly splendiferous.
All else being equal, a sharp share price increase should make a stock less attractive to potential investors. 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.
How Does Advance NanoTek's P/E Ratio Compare To Its Peers?
We can tell from its P/E ratio of 34.49 that sentiment around Advance NanoTek isn't particularly high. The image below shows that Advance NanoTek has a lower P/E than the average (40.1) P/E for companies in the chemicals industry.
This suggests that market participants think Advance NanoTek will underperform other companies in its industry. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.
How Growth Rates Impact P/E Ratios
Earnings growth rates have a big influence on P/E ratios. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. 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.
Advance NanoTek's earnings made like a rocket, taking off 266% last year. The cherry on top is that the five year growth rate was an impressive 212% per year. So I'd be surprised if the P/E ratio was not above average.
Remember: P/E Ratios Don't Consider The Balance Sheet
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. Theoretically, a business can improve its earnings (and produce a lower P/E in the future) by investing in growth. That means taking on debt (or spending its cash).
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 Advance NanoTek's Debt Impact Its P/E Ratio?
Since Advance NanoTek holds net cash of AU$353k, it can spend on growth, justifying a higher P/E ratio than otherwise.
The Bottom Line On Advance NanoTek's P/E Ratio
Advance NanoTek trades on a P/E ratio of 34.5, which is above its market average of 18.4. The excess cash it carries is the gravy on top its fast EPS growth. So based on this analysis we'd expect Advance NanoTek to have a high P/E ratio. What is very clear is that the market has become significantly more optimistic about Advance NanoTek over the last month, with the P/E ratio rising from 25.7 back then to 34.5 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.
When the market is wrong about a stock, it gives savvy investors an opportunity. People often underestimate remarkable growth -- so investors can make money when fast growth is not fully appreciated. We don't have analyst forecasts, but you might want to assess this data-rich visualization of earnings, revenue and cash flow.
But note: Advance NanoTek 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).
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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.