To the annoyance of some shareholders, Jumbo Interactive (ASX:JIN) shares are down a considerable 30% in the last month. The good news is that in the last year, the stock has shone bright like a diamond, gaining 120%.
Assuming nothing else has changed, a lower share price makes a stock more 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, on certain occasions, long term focussed investors try to take advantage of pessimistic expectations to buy shares at a better price. 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 Jumbo Interactive's P/E Ratio Compare To Its Peers?
We can tell from its P/E ratio of 33.40 that there is some investor optimism about Jumbo Interactive. The image below shows that Jumbo Interactive has a higher P/E than the average (24.1) P/E for companies in the hospitality industry.
Its relatively high P/E ratio indicates that Jumbo Interactive shareholders think it will perform better than other companies in its industry classification. Shareholders are clearly optimistic, but the future is always uncertain. So investors should delve deeper. I like to check if company insiders have been buying or selling.
How Growth Rates Impact P/E Ratios
Probably the most important factor in determining what P/E a company trades on is the earnings growth. 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. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
Jumbo Interactive's 94% EPS improvement over the last year was like bamboo growth after rain; rapid and impressive. The cherry on top is that the five year growth rate was an impressive 43% per year. So I'd be surprised if the P/E ratio was not above average.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
Don't forget that the P/E ratio considers market capitalization. Thus, the metric does not reflect cash or debt held by the company. 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 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.
So What Does Jumbo Interactive's Balance Sheet Tell Us?
The extra options and safety that comes with Jumbo Interactive's AU$85m net cash position means that it deserves a higher P/E than it would if it had a lot of net debt.
The Bottom Line On Jumbo Interactive's P/E Ratio
Jumbo Interactive trades on a P/E ratio of 33.4, which is above its market average of 18.8. The excess cash it carries is the gravy on top its fast EPS growth. So based on this analysis we'd expect Jumbo Interactive to have a high P/E ratio. Given Jumbo Interactive's P/E ratio has declined from 47.9 to 33.4 in the last month, we know for sure that the market is significantly less confident about the business today, than it was back then. For those who prefer to invest with the flow of momentum, that might be a bad sign, but for a contrarian, it may signal opportunity.
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 visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.
Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E 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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