Randall & Quilter Investment Holdings (LON:RQIH) shares have had a really impressive month, gaining 33%, after some slippage. Unfortunately, the full year gain of 6.1% wasn't so sweet.
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). 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 Randall & Quilter Investment Holdings's P/E Ratio Compare To Its Peers?
Randall & Quilter Investment Holdings's P/E of 8.56 indicates relatively low sentiment towards the stock. The image below shows that Randall & Quilter Investment Holdings has a lower P/E than the average (14.7) P/E for companies in the insurance industry.
Randall & Quilter Investment Holdings's P/E tells us that market participants think it will not fare as well as its peers in the same industry. Many investors like to buy stocks when the market is pessimistic about their prospects. 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
P/E ratios primarily reflect market expectations around earnings growth rates. That's because companies that grow earnings per share quickly will rapidly increase the 'E' in the equation. 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.
In the last year, Randall & Quilter Investment Holdings grew EPS like Taylor Swift grew her fan base back in 2010; the 181% gain was both fast and well deserved. The cherry on top is that the five year growth rate was an impressive 30% per year. With that kind of growth rate we would generally expect a high P/E ratio.
Remember: P/E Ratios Don't Consider The Balance Sheet
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. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
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.
So What Does Randall & Quilter Investment Holdings's Balance Sheet Tell Us?
With net cash of UK£168m, Randall & Quilter Investment Holdings has a very strong balance sheet, which may be important for its business. Having said that, at 40% of its market capitalization the cash hoard would contribute towards a higher P/E ratio.
The Verdict On Randall & Quilter Investment Holdings's P/E Ratio
Randall & Quilter Investment Holdings trades on a P/E ratio of 8.6, which is below the GB market average of 16.0. Not only should the net cash position reduce risk, but the recent growth has been impressive. The relatively low P/E ratio implies the market is pessimistic. What we know for sure is that investors are becoming less uncomfortable about Randall & Quilter Investment Holdings's prospects, since they have pushed its P/E ratio from 6.4 to 8.6 over the last month. If you like to buy stocks that could be turnaround opportunities, then this one might be a candidate; but if you're more sensitive to price, then you may feel the opportunity has passed.
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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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. Thank you for reading.