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How Does Alkane Resources's (ASX:ALK) P/E Compare To Its Industry, After Its Big Share Price Gain?

Simply Wall St

Alkane Resources (ASX:ALK) shares have continued recent momentum with a 33% gain in the last month alone. Zooming out, the annual gain of 259% knocks our socks off.

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. 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.

Check out our latest analysis for Alkane Resources

How Does Alkane Resources's P/E Ratio Compare To Its Peers?

We can tell from its P/E ratio of 17.16 that there is some investor optimism about Alkane Resources. As you can see below, Alkane Resources has a higher P/E than the average company (12.7) in the metals and mining industry.

ASX:ALK Price Estimation Relative to Market, October 13th 2019

That means that the market expects Alkane Resources will outperform other companies in its industry. The market is optimistic about the future, but that doesn't guarantee future growth. 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. Earnings growth means that in the future the 'E' will be higher. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.

Alkane Resources's earnings per share fell by 4.8% in the last twelve months. But it has grown its earnings per share by 60% per year over the last three years.

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. In other words, it does not consider any debt or cash that the company may have on the balance sheet. 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.

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 Alkane Resources's Debt Impact Its P/E Ratio?

With net cash of AU$70m, Alkane Resources has a very strong balance sheet, which may be important for its business. Having said that, at 17% of its market capitalization the cash hoard would contribute towards a higher P/E ratio.

The Bottom Line On Alkane Resources's P/E Ratio

Alkane Resources trades on a P/E ratio of 17.2, which is fairly close to the AU market average of 17.9. While the absence of growth in the last year is probably causing a degree of pessimism, the net cash position means it's not surprising that expectations put the company roughly in line with the market average P/E. What is very clear is that the market has become more optimistic about Alkane Resources over the last month, with the P/E ratio rising from 12.9 back then to 17.2 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 should be looking to buy stocks that the market is wrong about. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. Although we don't have analyst forecasts shareholders might want to examine this detailed historical graph of earnings, revenue and cash flow.

But note: Alkane Resources 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 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. Thank you for reading.