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How Does Digi International's (NASDAQ:DGII) P/E Compare To Its Industry, After Its Big Share Price Gain?

Simply Wall St

Digi International (NASDAQ:DGII) shareholders are no doubt pleased to see that the share price has bounced 59% in the last month alone, although it is still down 42% over the last quarter. But shareholders may not all be feeling jubilant, since the share price is still down 19% in the last year.

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. 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). Investors have optimistic expectations of companies with higher P/E ratios, compared to companies with lower P/E ratios.

View our latest analysis for Digi International

How Does Digi International's P/E Ratio Compare To Its Peers?

Digi International's P/E of 52.24 indicates some degree of optimism towards the stock. The image below shows that Digi International has a higher P/E than the average (26.4) P/E for companies in the communications industry.

NasdaqGS:DGII Price Estimation Relative to Market April 19th 2020

Its relatively high P/E ratio indicates that Digi International shareholders think it will perform better than other companies in its industry classification. Clearly the market expects growth, but it isn't guaranteed. So investors should delve deeper. I like to check if company insiders have been buying or selling.

How Growth Rates Impact P/E Ratios

If earnings fall then in the future the 'E' will be lower. Therefore, even if you pay a low multiple of earnings now, that multiple will become higher in the future. So while a stock may look cheap based on past earnings, it could be expensive based on future earnings.

Digi International shrunk earnings per share by 51% over the last year. But it has grown its earnings per share by 18% per year over the last five years. And over the longer term (3 years) earnings per share have decreased 26% annually. This growth rate might warrant a low P/E ratio.

Remember: P/E Ratios Don't Consider The Balance Sheet

The 'Price' in P/E reflects the market capitalization of the company. That means it doesn't take debt or cash into account. 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 Digi International's Debt Impact Its P/E Ratio?

Net debt totals 20% of Digi International's market cap. This could bring some additional risk, and reduce the number of investment options for management; worth remembering if you compare its P/E to businesses without debt.

The Bottom Line On Digi International's P/E Ratio

With a P/E ratio of 52.2, Digi International is expected to grow earnings very strongly in the years to come. With modest debt but no EPS growth in the last year, it's fair to say the P/E implies some optimism about future earnings, from the market. What we know for sure is that investors have become much more excited about Digi International recently, since they have pushed its P/E ratio from 32.8 to 52.2 over the last month. 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.

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. 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 Digi International. 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.