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eGain (NASDAQ:EGAN) shares have had a really impressive month, gaining 34%, after some slippage. And the full year gain of 28% isn't too shabby, either!
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). 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.
Does eGain Have A Relatively High Or Low P/E For Its Industry?
eGain's P/E of 61.24 indicates some degree of optimism towards the stock. You can see in the image below that the average P/E (45.3) for companies in the software industry is lower than eGain's P/E.
Its relatively high P/E ratio indicates that eGain shareholders think it will perform better than other companies in its industry classification. The market is optimistic about the future, but that doesn't guarantee future growth. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.
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. And in that case, the P/E ratio itself will drop rather quickly. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
Notably, eGain grew EPS by a whopping 37% in the last year.
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. 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 eGain's Balance Sheet Tell Us?
With net cash of US$41m, eGain has a very strong balance sheet, which may be important for its business. Having said that, at 13% of its market capitalization the cash hoard would contribute towards a higher P/E ratio.
The Bottom Line On eGain's P/E Ratio
eGain's P/E is 61.2 which suggests the market is more focussed on the future opportunity rather than the current level of earnings. Its net cash position is the cherry on top of its superb EPS growth. So based on this analysis we'd expect eGain to have a high P/E ratio. What we know for sure is that investors have become much more excited about eGain recently, since they have pushed its P/E ratio from 45.6 to 61.2 over the last month. 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.
When the market is wrong about a stock, it gives savvy investors an opportunity. 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.
Of course you might be able to find a better stock than eGain. 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 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.
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