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A Rising Share Price Has Us Looking Closely At Ratti S.p.A.'s (BIT:RAT) P/E Ratio

Simply Wall St

It's really great to see that even after a strong run, Ratti (BIT:RAT) shares have been powering on, with a gain of 41% in the last thirty days. That's tops off a massive gain of 139% in the last year.

Assuming no other changes, a sharply higher share price makes a stock less attractive to potential buyers. 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). Investors have optimistic expectations of companies with higher P/E ratios, compared to companies with lower P/E ratios.

View our latest analysis for Ratti

How Does Ratti's P/E Ratio Compare To Its Peers?

We can tell from its P/E ratio of 14.26 that sentiment around Ratti isn't particularly high. The image below shows that Ratti has a lower P/E than the average (21.6) P/E for companies in the luxury industry.

BIT:RAT Price Estimation Relative to Market, January 22nd 2020

This suggests that market participants think Ratti will underperform other companies in its industry. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. You should delve deeper. I like to check if company insiders have been buying or selling.

How Growth Rates Impact P/E Ratios

P/E ratios primarily reflect market expectations around earnings growth rates. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. That means even if the current P/E is high, it will reduce over time if the share price stays flat. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.

In the last year, Ratti grew EPS like Taylor Swift grew her fan base back in 2010; the 64% gain was both fast and well deserved. The sweetener is that the annual five year growth rate of 32% is also impressive. 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

The 'Price' in P/E reflects the market capitalization of the company. Thus, the metric does not reflect cash or debt held by the company. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.

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 Ratti's Balance Sheet Tell Us?

The extra options and safety that comes with Ratti's €7.4m 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 Ratti's P/E Ratio

Ratti's P/E is 14.3 which is below average (18.7) in the IT market. The net cash position gives plenty of options to the business, and the recent improvement in EPS is good to see. The relatively low P/E ratio implies the market is pessimistic. What is very clear is that the market has become more optimistic about Ratti over the last month, with the P/E ratio rising from 10.1 back then to 14.3 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. 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 be able to find a better stock than Ratti. So you may wish to see this free collection of other companies that have grown earnings strongly.

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.