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What Is Prime People's (LON:PRP) P/E Ratio After Its Share Price Rocketed?

Simply Wall St

Prime People (LON:PRP) shares have continued recent momentum with a 44% gain in the last month alone. Looking back a bit further, we're also happy to report the stock is up 87% in the last year.

All else being equal, a sharp share price increase should make a stock less attractive to potential investors. In the long term, share prices tend to follow earnings per share, but in the short term prices bounce around in response to short term factors (which are not always obvious). So some would prefer to hold off buying when there is a lot of optimism towards a stock. 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.

View our latest analysis for Prime People

Does Prime People Have A Relatively High Or Low P/E For Its Industry?

We can tell from its P/E ratio of 11.30 that sentiment around Prime People isn't particularly high. If you look at the image below, you can see Prime People has a lower P/E than the average (24.2) in the professional services industry classification.

AIM:PRP Price Estimation Relative to Market, January 15th 2020

Its relatively low P/E ratio indicates that Prime People shareholders think it will struggle to do as well as other companies in its industry classification. Since the market seems unimpressed with Prime People, it's quite possible it could surprise on the upside. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and selling.

How Growth Rates Impact P/E Ratios

Earnings growth rates have a big influence on P/E ratios. When earnings grow, the 'E' increases, over time. That means even if the current P/E is high, it will reduce over time if the share price stays flat. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.

Prime People saw earnings per share decrease by 22% last year. But over the longer term (5 years) earnings per share have increased by 5.6%.

A Limitation: P/E Ratios Ignore Debt and Cash In The Bank

The 'Price' in P/E reflects the market capitalization of the company. So it won't reflect the advantage of cash, or disadvantage of debt. Theoretically, a business can improve its earnings (and produce a lower P/E in the future) by investing in growth. That means taking on debt (or spending its cash).

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 Prime People's Balance Sheet Tell Us?

Prime People has net cash of UK£3.0m. This is fairly high at 18% of its market capitalization. That might mean balance sheet strength is important to the business, but should also help push the P/E a bit higher than it would otherwise be.

The Bottom Line On Prime People's P/E Ratio

Prime People has a P/E of 11.3. That's below the average in the GB market, which is 18.5. The recent drop in earnings per share would make investors cautious, the relatively strong balance sheet will allow the company time to invest in growth. If it achieves that, then there's real potential that the low P/E could eventually indicate undervaluation. What is very clear is that the market has become more optimistic about Prime People over the last month, with the P/E ratio rising from 7.9 back then to 11.3 today. 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 it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. Although we don't have analyst forecasts you could get a better understanding of its growth by checking out this more detailed historical graph of earnings, revenue and cash flow.

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 editorial-team@simplywallst.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.