The G5 Entertainment (STO:G5EN) share price has done well in the last month, posting a gain of 39%. Looking back a bit further, we're also happy to report the stock is up 73% in the last year.
All else being equal, a sharp share price increase should make a stock less attractive to potential investors. 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. 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). 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.
How Does G5 Entertainment's P/E Ratio Compare To Its Peers?
We can tell from its P/E ratio of 34.95 that sentiment around G5 Entertainment isn't particularly high. We can see in the image below that the average P/E (72.3) for companies in the entertainment industry is higher than G5 Entertainment's P/E.
This suggests that market participants think G5 Entertainment will underperform other companies in its industry. Since the market seems unimpressed with G5 Entertainment, it's quite possible it could surprise on the upside. You 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. 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.
G5 Entertainment shrunk earnings per share by 65% over the last year. But over the longer term (5 years) earnings per share have increased by 53%. And over the longer term (3 years) earnings per share have decreased 2.7% annually. This could justify a low P/E.
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. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.
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 G5 Entertainment's Debt Impact Its P/E Ratio?
With net cash of kr186m, G5 Entertainment has a very strong balance sheet, which may be important for its business. Having said that, at 13% of its market capitalization the cash hoard would contribute towards a higher P/E ratio.
The Verdict On G5 Entertainment's P/E Ratio
G5 Entertainment has a P/E of 34.9. That's higher than the average in its market, which is 16.6. The recent drop in earnings per share might keep value investors away, but the healthy balance sheet means the company retains the potential for future growth. If this growth fails to materialise, the current high P/E could prove to be temporary, as the share price falls. What we know for sure is that investors have become much more excited about G5 Entertainment recently, since they have pushed its P/E ratio from 25.1 to 34.9 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 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 visual report on analyst forecasts could hold the key to an excellent investment decision.
But note: G5 Entertainment 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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