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A Rising Share Price Has Us Looking Closely At Alkane Resources Limited's (ASX:ALK) P/E Ratio

Simply Wall St

It's great to see Alkane Resources (ASX:ALK) shareholders have their patience rewarded with a 97% share price pop in the last month. That's tops off a massive gain of 225% in the last year.

All else being equal, a sharp share price increase should make a stock less attractive to potential investors. 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). 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 Alkane Resources

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

We can tell from its P/E ratio of 16.95 that there is some investor optimism about Alkane Resources. The image below shows that Alkane Resources has a higher P/E than the average (13.5) P/E for companies in the metals and mining industry.

ASX:ALK Price Estimation Relative to Market, September 20th 2019

That means that the market expects Alkane Resources will outperform other companies in its industry. The market is optimistic about the future, but that doesn't guarantee future growth. So investors should delve deeper. I like to check if company insiders have been buying or selling.

How Growth Rates Impact P/E Ratios

Earnings growth rates have a big influence on P/E ratios. Earnings growth means that in the future the 'E' will be higher. That means unless the share price increases, the P/E will reduce in a few years. Then, a lower P/E should attract more buyers, pushing the share price up.

Alkane Resources saw earnings per share decrease by 4.8% last year. But over the longer term (3 years), earnings per share have increased by 60%.

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

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. Theoretically, a business can improve its earnings (and produce a lower P/E in the future) by investing in growth. That means taking on debt (or spending its cash).

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.

So What Does Alkane Resources's Balance Sheet Tell Us?

With net cash of AU$70m, Alkane Resources has a very strong balance sheet, which may be important for its business. Having said that, at 20% of its market capitalization the cash hoard would contribute towards a higher P/E ratio.

The Verdict On Alkane Resources's P/E Ratio

Alkane Resources has a P/E of 16.9. That's around the same as the average in the AU market, which is 18.2. Although the recent drop in earnings per share would keep the market cautious, the net cash position means it's not surprising that expectations put the company roughly in line with the market average P/E. What is very clear is that the market has become significantly more optimistic about Alkane Resources over the last month, with the P/E ratio rising from 8.6 back then to 16.9 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.

When the market is wrong about a stock, it gives savvy investors an opportunity. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. So this free visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.

But note: Alkane Resources 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).

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.

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. Thank you for reading.