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A Rising Share Price Has Us Looking Closely At Enghouse Systems Limited's (TSE:ENGH) P/E Ratio

Simply Wall St

Enghouse Systems (TSE:ENGH) shareholders are no doubt pleased to see that the share price has had a great month, posting a 38% gain, recovering from prior weakness. Looking back a bit further, we're also happy to report the stock is up 60% 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). So some would prefer to hold off buying when there is a lot of optimism towards a stock. 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.

See our latest analysis for Enghouse Systems

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

Enghouse Systems's P/E of 39.87 indicates some degree of optimism towards the stock. As you can see below, Enghouse Systems has a higher P/E than the average company (27.3) in the software industry.

TSX:ENGH Price Estimation Relative to Market April 20th 2020
TSX:ENGH Price Estimation Relative to Market April 20th 2020

Enghouse Systems's P/E tells us that market participants think the company will perform better than its industry peers, going forward. Shareholders are clearly optimistic, but the future is always uncertain. So investors should delve deeper. I like to check if company insiders have been buying or selling.

How Growth Rates Impact P/E Ratios

Generally speaking the rate of earnings growth has a profound impact on a company's P/E multiple. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. That means unless the share price increases, the P/E will reduce in a few years. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.

Enghouse Systems increased earnings per share by 8.7% last year. And its annual EPS growth rate over 5 years is 21%.

Remember: P/E Ratios Don't Consider The Balance Sheet

The 'Price' in P/E reflects the market capitalization of the company. That means it doesn't take debt or cash into account. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.

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).

How Does Enghouse Systems's Debt Impact Its P/E Ratio?

The extra options and safety that comes with Enghouse Systems's CA$115m 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 Enghouse Systems's P/E Ratio

Enghouse Systems has a P/E of 39.9. That's significantly higher than the average in its market, which is 11.7. EPS was up modestly better over the last twelve months. And the net cash position provides the company with multiple options. The high P/E suggests the market thinks further growth will come. What is very clear is that the market has become significantly more optimistic about Enghouse Systems over the last month, with the P/E ratio rising from 28.9 back then to 39.9 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.

Investors have an opportunity when market expectations about a stock are wrong. 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.

But note: Enghouse Systems may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio 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.

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