It's really great to see that even after a strong run, K3 Capital Group (LON:K3C) shares have been powering on, with a gain of 37% in the last thirty days. But shareholders may not all be feeling jubilant, since the share price is still down 12% in the last 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). 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 K3 Capital Group's P/E Ratio Compare To Its Peers?
K3 Capital Group's P/E is 26.16. The image below shows that K3 Capital Group has a P/E ratio that is roughly in line with the professional services industry average (24.9).
K3 Capital Group's P/E tells us that market participants think its prospects are roughly in line with its industry. So if K3 Capital Group actually outperforms its peers going forward, that should be a positive for the share price. I would further inform my view by checking insider buying and selling., among other things.
How Growth Rates Impact P/E Ratios
Companies that shrink earnings per share quickly will rapidly decrease the 'E' in the equation. That means even if the current P/E is low, it will increase over time if the share price stays flat. A higher P/E should indicate the stock is expensive relative to others -- and that may encourage shareholders to sell.
K3 Capital Group shrunk earnings per share by 33% over the last year. And over the longer term (5 years) earnings per share have decreased 13% annually. This might lead to muted expectations.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. So it won't reflect the advantage of cash, or disadvantage of debt. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.
Spending on growth might be good or bad a few years later, but the point is that the P/E ratio does not account for the option (or lack thereof).
K3 Capital Group's Balance Sheet
The extra options and safety that comes with K3 Capital Group's UK£5.8m 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 K3 Capital Group's P/E Ratio
K3 Capital Group trades on a P/E ratio of 26.2, which is above its market average of 18.3. The recent drop in earnings per share would make some investors cautious, but the healthy balance sheet means the company retains potential for future growth. If fails to eventuate, 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 K3 Capital Group recently, since they have pushed its P/E ratio from 19.2 to 26.2 over the last month. 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 should be looking to buy stocks that the market is wrong about. 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 K3 Capital Group. 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 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.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.