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A Rising Share Price Has Us Looking Closely At JEMTEC Inc.'s (CVE:JTC) P/E Ratio

Simply Wall St

JEMTEC (CVE:JTC) shareholders are no doubt pleased to see that the share price has had a great month, posting a 50% gain, recovering from prior weakness. That's tops off a massive gain of 102% 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). 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.

Check out our latest analysis for JEMTEC

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

We can tell from its P/E ratio of 10.53 that sentiment around JEMTEC isn't particularly high. The image below shows that JEMTEC has a lower P/E than the average (15.5) P/E for companies in the electronic industry.

TSXV:JTC Price Estimation Relative to Market, November 23rd 2019

This suggests that market participants think JEMTEC will underperform other companies in its industry. Many investors like to buy stocks when the market is pessimistic about their prospects. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.

How Growth Rates Impact P/E Ratios

P/E ratios primarily reflect market expectations around earnings growth rates. Earnings growth means that in the future the 'E' will be higher. 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.

JEMTEC's 101% EPS improvement over the last year was like bamboo growth after rain; rapid and impressive.

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

One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. That means it doesn't take debt or cash into account. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.

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).

JEMTEC's Balance Sheet

JEMTEC has net cash of CA$2.2m. This is fairly high at 38% 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 Verdict On JEMTEC's P/E Ratio

JEMTEC has a P/E of 10.5. That's below the average in the CA market, which is 14.6. Not only should the net cash position reduce risk, but the recent growth has been impressive. The below average P/E ratio suggests that market participants don't believe the strong growth will continue. What we know for sure is that investors have become more excited about JEMTEC recently, since they have pushed its P/E ratio from 7.0 to 10.5 over the last month. 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 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. We don't have analyst forecasts, but you might want to assess this data-rich visualization of earnings, revenue and cash flow.

Of course you might be able to find a better stock than JEMTEC. 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.