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How Does Citadel Group's (ASX:CGL) P/E Compare To Its Industry, After Its Big Share Price Gain?

Simply Wall St

Citadel Group (ASX:CGL) shareholders are no doubt pleased to see that the share price has had a great month, posting a 37% gain, recovering from prior weakness. But shareholders may not all be feeling jubilant, since the share price is still down 46% in the last year.

All else being equal, a sharp share price increase should make a stock less attractive to potential investors. 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). 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). 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 Citadel Group

How Does Citadel Group's P/E Ratio Compare To Its Peers?

Citadel Group has a P/E ratio of 26.21. As you can see below Citadel Group has a P/E ratio that is fairly close for the average for the it industry, which is 26.2.

ASX:CGL Price Estimation Relative to Market, November 29th 2019

That indicates that the market expects Citadel Group will perform roughly in line with other companies in its industry. So if Citadel Group actually outperforms its peers going forward, that should be a positive for the share price. Further research into factors such as insider buying and selling, could help you form your own view on whether that is likely.

How Growth Rates Impact P/E Ratios

If earnings fall then in the future the 'E' will be lower. That means even if the current P/E is low, it will increase over time if the share price stays flat. Then, a higher P/E might scare off shareholders, pushing the share price down.

Citadel Group saw earnings per share decrease by 51% last year. But over the longer term (5 years) earnings per share have increased by 5.2%. And over the longer term (3 years) earnings per share have decreased 1.7% annually. This might lead to low expectations.

A Limitation: P/E Ratios Ignore Debt and Cash In The Bank

It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. Thus, the metric does not reflect cash or debt held by the company. 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.

Such expenditure might be good or bad, in the long term, but the point here is that the balance sheet is not reflected by this ratio.

So What Does Citadel Group's Balance Sheet Tell Us?

Since Citadel Group holds net cash of AU$2.5m, it can spend on growth, justifying a higher P/E ratio than otherwise.

The Bottom Line On Citadel Group's P/E Ratio

Citadel Group's P/E is 26.2 which is above average (18.8) in its market. Falling earnings per share is probably keeping traditional 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 is very clear is that the market has become significantly more optimistic about Citadel Group over the last month, with the P/E ratio rising from 19.1 back then to 26.2 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.

Investors have an opportunity when market expectations about a stock are wrong. People often underestimate remarkable growth -- so investors can make money when fast growth is not fully appreciated. So this free report on the analyst consensus forecasts could help you make a master move on this stock.

Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.

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.