Those holding Rectifier Technologies (ASX:RFT) shares must be pleased that the share price has rebounded 20% in the last thirty days. But unfortunately, the stock is still down by 27% over a quarter. But shareholders may not all be feeling jubilant, since the share price is still down 35% 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 implies that investors have high expectations of what a company can achieve compared to a company with a low P/E ratio.
Does Rectifier Technologies Have A Relatively High Or Low P/E For Its Industry?
Rectifier Technologies has a P/E ratio of 17.10. You can see in the image below that the average P/E (17.1) for companies in the electrical industry is roughly the same as Rectifier Technologies's P/E.
That indicates that the market expects Rectifier Technologies will perform roughly in line with other companies in its industry. If the company has better than average prospects, then the market might be underestimating it. I would further inform my view by checking insider buying and selling., among other things.
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. That means even if the current P/E is high, it will reduce over time if the share price stays flat. And as that P/E ratio drops, the company will look cheap, unless its share price increases.
In the last year, Rectifier Technologies grew EPS like Taylor Swift grew her fan base back in 2010; the 169% gain was both fast and well deserved. The sweetener is that the annual five year growth rate of 31% is also impressive. So I'd be surprised if the P/E ratio was not above average.
Remember: P/E Ratios Don't Consider The Balance Sheet
The 'Price' in P/E reflects the market capitalization of the company. So it won't reflect the advantage of cash, or disadvantage of debt. 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).
While growth expenditure doesn't always pay off, the point is that it is a good option to have; but one that the P/E ratio ignores.
How Does Rectifier Technologies's Debt Impact Its P/E Ratio?
Since Rectifier Technologies holds net cash of AU$2.5m, it can spend on growth, justifying a higher P/E ratio than otherwise.
The Verdict On Rectifier Technologies's P/E Ratio
Rectifier Technologies's P/E is 17.1 which is above average (14.6) in its market. Its net cash position is the cherry on top of its superb EPS growth. To us, this is the sort of company that we would expect to carry an above average price tag (relative to earnings). What we know for sure is that investors have become more excited about Rectifier Technologies recently, since they have pushed its P/E ratio from 14.3 to 17.1 over the last month. 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 should be looking to buy stocks that the market is wrong about. People often underestimate remarkable growth -- so investors can make money when fast growth is not fully appreciated. Although we don't have analyst forecasts shareholders might want to examine this detailed historical graph of earnings, revenue and cash flow.
But note: Rectifier Technologies 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).
If you spot an error that warrants correction, please contact the editor at email@example.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.
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