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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

Alkane Resources (ASX:ALK) shareholders are no doubt pleased to see that the share price has had a great month, posting a 39% gain, recovering from prior weakness. Zooming out, the stock's 314% gain in the last year is certainly splendiferous.

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). 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

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

Alkane Resources's P/E of 16.62 indicates some degree of optimism towards the stock. You can see in the image below that the average P/E (13.1) for companies in the metals and mining industry is lower than Alkane Resources's P/E.

ASX:ALK Price Estimation Relative to Market, January 28th 2020

Alkane Resources's P/E tells us that market participants think the company will perform better than its industry peers, going forward. Clearly the market expects growth, but it isn't guaranteed. So further research is always essential. I often monitor director buying and selling.

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. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. That means unless the share price increases, the P/E will reduce in a few years. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.

Alkane Resources's earnings per share fell by 4.8% in the last twelve months. But over the longer term (3 years), earnings per share have increased by 60%.

Remember: P/E Ratios Don't Consider The Balance Sheet

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. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.

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.

How Does Alkane Resources's Debt Impact Its P/E Ratio?

Alkane Resources has net cash of AU$70m. This is fairly high at 18% of its market capitalization. That might mean balance sheet strength is important to the business, but should also help push the P/E a bit higher than it would otherwise be.

The Bottom Line On Alkane Resources's P/E Ratio

Alkane Resources has a P/E of 16.6. That's below the average in the AU market, which is 18.8. Falling earnings per share are likely to be keeping potential buyers away, the relatively strong balance sheet will allow the company time to invest in growth. If it achieves that, then there's real potential that the low P/E could eventually indicate undervaluation. What we know for sure is that investors have become more excited about Alkane Resources recently, since they have pushed its P/E ratio from 12.0 to 16.6 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.

When the market is wrong about a stock, it gives savvy investors an opportunity. If the reality for a company is not as bad as the P/E ratio indicates, then the share price should increase as the market realizes this. So this free report on the analyst consensus forecasts could help you make a master move on this stock.

You might be able to find a better buy than Alkane Resources. 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 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.

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.