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

Simply Wall St

Konekt (ASX:KKT) shares have continued recent momentum with a 83% gain in the last month alone. That brought the twelve month gain to a very sharp 62%.

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. 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 implies that investors have high expectations of what a company can achieve compared to a company with a low P/E ratio.

View our latest analysis for Konekt

Does Konekt Have A Relatively High Or Low P/E For Its Industry?

Konekt's P/E of 31.49 indicates some degree of optimism towards the stock. As you can see below, Konekt has a higher P/E than the average company (18.8) in the healthcare industry.

ASX:KKT Price Estimation Relative to Market, October 8th 2019

That means that the market expects Konekt will outperform other companies in its industry. Clearly the market expects growth, but it isn't guaranteed. So investors should delve deeper. I like to check if company insiders have been buying or selling.

How Growth Rates Impact P/E Ratios

When earnings fall, the 'E' decreases, over time. Therefore, even if you pay a low multiple of earnings now, that multiple will become higher in the future. Then, a higher P/E might scare off shareholders, pushing the share price down.

In the last year, Konekt grew EPS like Taylor Swift grew her fan base back in 2010; the 135% gain was both fast and well deserved. Regrettably, the longer term performance is poor, with EPS down -2.7% per year over 3 years.

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

It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. Thus, the metric does not reflect cash or debt held by the company. 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 Konekt's Balance Sheet Tell Us?

Konekt's net debt equates to 33% of its market capitalization. You'd want to be aware of this fact, but it doesn't bother us.

The Bottom Line On Konekt's P/E Ratio

Konekt has a P/E of 31.5. That's higher than the average in its market, which is 18.4. While the company does use modest debt, its recent earnings growth is superb. So on this analysis a high P/E ratio seems reasonable. What is very clear is that the market has become significantly more optimistic about Konekt over the last month, with the P/E ratio rising from 17.2 back then to 31.5 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 have an opportunity when market expectations about a stock are wrong. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. Although we don't have analyst forecasts you might want to assess this data-rich visualization of earnings, revenue and cash flow.

Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E 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.