Those holding PagSeguro Digital (NYSE:PAGS) shares must be pleased that the share price has rebounded 37% in the last thirty days. But unfortunately, the stock is still down by 22% over a quarter. The bad news is that even after that recovery shareholders are still underwater by about 6.7% for the full year.
Assuming no other changes, a sharply higher share price makes a stock less attractive to potential buyers. While the market sentiment towards a stock is very changeable, in the long run, the share price will tend to move in the same direction as earnings per share. 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 PagSeguro Digital Have A Relatively High Or Low P/E For Its Industry?
We can tell from its P/E ratio of 32.90 that there is some investor optimism about PagSeguro Digital. You can see in the image below that the average P/E (29.8) for companies in the it industry is lower than PagSeguro Digital's P/E.
PagSeguro Digital'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 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
Probably the most important factor in determining what P/E a company trades on is the earnings growth. When earnings grow, the 'E' increases, over time. And in that case, the P/E ratio itself will drop rather quickly. Then, a lower P/E should attract more buyers, pushing the share price up.
Notably, PagSeguro Digital grew EPS by a whopping 45% in the last year. And earnings per share have improved by 111% annually, over the last five years. So we'd generally expect it to have a relatively high P/E ratio.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
The 'Price' in P/E reflects the market capitalization of the company. That means it doesn't take debt or cash into account. The exact same company would hypothetically deserve a higher P/E ratio if it had a strong balance sheet, than if it had a weak one with lots of debt, because a cashed up company can spend on growth.
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.
Is Debt Impacting PagSeguro Digital's P/E?
Since PagSeguro Digital holds net cash of R$2.8b, it can spend on growth, justifying a higher P/E ratio than otherwise.
The Bottom Line On PagSeguro Digital's P/E Ratio
PagSeguro Digital has a P/E of 32.9. That's higher than the average in its market, which is 14.9. The excess cash it carries is the gravy on top its fast EPS growth. So based on this analysis we'd expect PagSeguro Digital to have a high P/E ratio. What is very clear is that the market has become significantly more optimistic about PagSeguro Digital over the last month, with the P/E ratio rising from 24.0 back then to 32.9 today. 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.
Investors should be looking to buy stocks that the market is wrong about. 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 visual report on analyst forecasts could hold the key to an excellent investment decision.
You might be able to find a better buy than PagSeguro Digital. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
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.
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.