G5 Entertainment (STO:G5EN) shareholders are no doubt pleased to see that the share price has bounced 38% in the last month alone, although it is still down 11% over the last quarter. The bad news is that even after that recovery shareholders are still underwater by about 3.5% for the full 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. 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.
How Does G5 Entertainment's P/E Ratio Compare To Its Peers?
We can tell from its P/E ratio of 16.32 that sentiment around G5 Entertainment isn't particularly high. The image below shows that G5 Entertainment has a lower P/E than the average (32.6) P/E for companies in the entertainment industry.
G5 Entertainment's P/E tells us that market participants think it will not fare as well as its peers in the same industry. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.
How Growth Rates Impact P/E Ratios
P/E ratios primarily reflect market expectations around earnings growth rates. Earnings growth means that in the future the 'E' will be higher. 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.
G5 Entertainment saw earnings per share decrease by 48% last year. But EPS is up 23% over the last 3 years.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
Don't forget that the P/E ratio considers market capitalization. So it won't reflect the advantage of cash, or disadvantage of debt. 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.
G5 Entertainment's Balance Sheet
With net cash of kr128m, G5 Entertainment has a very strong balance sheet, which may be important for its business. Having said that, at 12% of its market capitalization the cash hoard would contribute towards a higher P/E ratio.
The Bottom Line On G5 Entertainment's P/E Ratio
G5 Entertainment trades on a P/E ratio of 16.3, which is below the SE market average of 19.4. Falling earnings per share are likely to be keeping potential buyers away, but the net cash position means the company has time to improve: if so, the low P/E could be an opportunity. What is very clear is that the market has become more optimistic about G5 Entertainment over the last month, with the P/E ratio rising from 11.9 back then to 16.3 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 should be looking to buy stocks that the market is wrong about. If the reality for a company is not as bad as the P/E ratio indicates, then the share price should increase as the market realizes this. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.
You might be able to find a better buy than G5 Entertainment. 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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