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How Does Caledonia Mining's (TSE:CAL) P/E Compare To Its Industry, After Its Big Share Price Gain?

Simply Wall St

It's really great to see that even after a strong run, Caledonia Mining (TSE:CAL) shares have been powering on, with a gain of 33% in the last thirty days. Zooming out, the annual gain of 125% knocks our socks off.

Assuming no other changes, a sharply higher share price makes a stock less attractive to potential buyers. 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. 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.

Check out our latest analysis for Caledonia Mining

How Does Caledonia Mining's P/E Ratio Compare To Its Peers?

We can tell from its P/E ratio of 3.29 that sentiment around Caledonia Mining isn't particularly high. If you look at the image below, you can see Caledonia Mining has a lower P/E than the average (16.3) in the metals and mining industry classification.

TSX:CAL Price Estimation Relative to Market April 27th 2020
TSX:CAL Price Estimation Relative to Market April 27th 2020

Its relatively low P/E ratio indicates that Caledonia Mining shareholders think it will struggle to do as well as other companies in its industry classification. Since the market seems unimpressed with Caledonia Mining, it's quite possible it could surprise on the upside. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and selling.

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. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. Then, a lower P/E should attract more buyers, pushing the share price up.

Caledonia Mining's 286% EPS improvement over the last year was like bamboo growth after rain; rapid and impressive. The cherry on top is that the five year growth rate was an impressive 55% per year. With that kind of growth rate we would generally expect a high P/E ratio.

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

So What Does Caledonia Mining's Balance Sheet Tell Us?

Since Caledonia Mining holds net cash of US$6.4m, it can spend on growth, justifying a higher P/E ratio than otherwise.

The Verdict On Caledonia Mining's P/E Ratio

Caledonia Mining trades on a P/E ratio of 3.3, which is below the CA market average of 11.6. It grew its EPS nicely over the last year, and the healthy balance sheet implies there is more potential for growth. The relatively low P/E ratio implies the market is pessimistic. What we know for sure is that investors are becoming less uncomfortable about Caledonia Mining's prospects, since they have pushed its P/E ratio from 2.5 to 3.3 over the last month. For those who like to invest in turnarounds, that might mean it's time to put the stock on a watchlist, or research it. But others might consider the opportunity to have passed.

Investors should be looking to buy stocks that the market is wrong about. If the reality for a company is not as bad as the P/E ratio indicates, then the share price should increase as the market realizes this. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.

Of course you might be able to find a better stock than Caledonia Mining. So you may wish to see this free collection of other companies that have grown earnings strongly.

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.