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A Rising Share Price Has Us Looking Closely At Academies Australasia Group Limited's (ASX:AKG) P/E Ratio

Simply Wall St

Academies Australasia Group (ASX:AKG) shares have continued recent momentum with a 30% gain in the last month alone. That brought the twelve month gain to a very sharp 73%.

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. Perhaps the simplest way to get a read on investors' expectations of a business 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.

View our latest analysis for Academies Australasia Group

How Does Academies Australasia Group's P/E Ratio Compare To Its Peers?

Academies Australasia Group's P/E is 18.79. The image below shows that Academies Australasia Group has a P/E ratio that is roughly in line with the consumer services industry average (18.2).

ASX:AKG Price Estimation Relative to Market, October 2nd 2019

Its P/E ratio suggests that Academies Australasia Group shareholders think that in the future it will perform about the same as other companies in its industry classification. So if Academies Australasia Group actually outperforms its peers going forward, that should be a positive for the share price. Further research into factors such as insider buying and selling, could help you form your own view on whether that is likely.

How Growth Rates Impact P/E Ratios

Earnings growth rates have a big influence on P/E ratios. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.

It's great to see that Academies Australasia Group grew EPS by 11% in the last year. In contrast, EPS has decreased by 14%, annually, over 5 years.

Don't Forget: The P/E Does Not Account For Debt or Bank Deposits

One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. 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.

Such spending might be good or bad, overall, but the key point here is that you need to look at debt to understand the P/E ratio in context.

So What Does Academies Australasia Group's Balance Sheet Tell Us?

With net cash of AU$15m, Academies Australasia Group has a very strong balance sheet, which may be important for its business. Having said that, at 17% of its market capitalization the cash hoard would contribute towards a higher P/E ratio.

The Verdict On Academies Australasia Group's P/E Ratio

Academies Australasia Group's P/E is 18.8 which is about average (18.3) in the AU market. The balance sheet is healthy, and recent EPS growth impressive, but the P/E implies some caution from the market. What we know for sure is that investors have become more excited about Academies Australasia Group recently, since they have pushed its P/E ratio from 14.4 to 18.8 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 have an opportunity when market expectations about a stock are wrong. As value investor Benjamin Graham famously said, 'In the short run, the market is a voting machine but in the long run, it is a weighing machine. 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 Academies Australasia Group. So you may wish to see this free collection of other companies that have grown earnings strongly.

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.