Manhattan Associates (NASDAQ:MANH) shareholders are no doubt pleased to see that the share price has bounced 33% in the last month alone, although it is still down 6.8% over the last quarter. However, the annual gain of 8.9% wasn't so impressive.
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. 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 implies that investors have high expectations of what a company can achieve compared to a company with a low P/E ratio.
Does Manhattan Associates Have A Relatively High Or Low P/E For Its Industry?
Manhattan Associates's P/E of 53.91 indicates some degree of optimism towards the stock. As you can see below, Manhattan Associates has a higher P/E than the average company (45.2) in the software industry.
Its relatively high P/E ratio indicates that Manhattan Associates 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 always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.
How Growth Rates Impact P/E Ratios
If earnings fall then in the future the 'E' will be lower. That means unless the share price falls, the P/E will increase in a few years. So while a stock may look cheap based on past earnings, it could be expensive based on future earnings.
Manhattan Associates's earnings per share fell by 13% in the last twelve months. But over the longer term (5 years) earnings per share have increased by 3.3%. And over the longer term (3 years) earnings per share have decreased 8.2% annually. This could justify a low P/E.
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. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
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.
So What Does Manhattan Associates's Balance Sheet Tell Us?
The extra options and safety that comes with Manhattan Associates's US$75m net cash position means that it deserves a higher P/E than it would if it had a lot of net debt.
The Verdict On Manhattan Associates's P/E Ratio
Manhattan Associates's P/E is 53.9 which suggests the market is more focussed on the future opportunity rather than the current level of earnings. The recent drop in earnings per share would make some investors cautious, 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 is very clear is that the market has become significantly more optimistic about Manhattan Associates over the last month, with the P/E ratio rising from 40.6 back then to 53.9 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.
When the market is wrong about a stock, it gives savvy investors an opportunity. As value investor Benjamin Graham famously said, 'In the short run, the market is a voting machine but in the long run, it is a weighing machine. So this free report on the analyst consensus forecasts could help you make a master move on this stock.
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.
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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. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned. Thank you for reading.