Fortinet (NASDAQ:FTNT) shares have had a really impressive month, gaining 30%, after some slippage. That brought the twelve month gain to a very sharp 74%.
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. 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.
Does Fortinet Have A Relatively High Or Low P/E For Its Industry?
We can tell from its P/E ratio of 66.02 that there is some investor optimism about Fortinet. You can see in the image below that the average P/E (44.7) for companies in the software industry is lower than Fortinet's P/E.
That means that the market expects Fortinet will outperform other companies in its industry. Clearly the market expects growth, but it isn't guaranteed. So further research is always essential. 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. When earnings grow, the 'E' increases, over time. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.
Fortinet saw earnings per share improve by 5.5% last year. And its annual EPS growth rate over 5 years is 81%.
Remember: P/E Ratios Don't Consider The Balance Sheet
Don't forget that the P/E ratio considers market capitalization. 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 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 Fortinet's Balance Sheet Tell Us?
Since Fortinet holds net cash of US$1.4b, it can spend on growth, justifying a higher P/E ratio than otherwise.
The Bottom Line On Fortinet's P/E Ratio
Fortinet's P/E is 66.0 which suggests the market is more focussed on the future opportunity rather than the current level of earnings. EPS was up modestly better over the last twelve months. And the net cash position provides the company with multiple options. The high P/E suggests the market thinks further growth will come. What is very clear is that the market has become significantly more optimistic about Fortinet over the last month, with the P/E ratio rising from 50.8 back then to 66.0 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 have an opportunity when market expectations about a stock are wrong. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. So this free report on the analyst consensus forecasts could help you make a master move on this stock.
You might be able to find a better buy than Fortinet. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
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.
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