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

Simply Wall St

It's really great to see that even after a strong run, Gullewa (ASX:GUL) shares have been powering on, with a gain of 35% in the last thirty days. That brought the twelve month gain to a very sharp 59%.

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.

See our latest analysis for Gullewa

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

We can tell from its P/E ratio of 5.28 that sentiment around Gullewa isn't particularly high. If you look at the image below, you can see Gullewa has a lower P/E than the average (13.5) in the metals and mining industry classification.

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

Gullewa's P/E tells us that market participants think it will not fare as well as its peers in the same industry. Since the market seems unimpressed with Gullewa, it's quite possible it could surprise on the upside. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.

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. Earnings growth means that in the future the 'E' will be higher. That means even if the current P/E is high, it will reduce over time if the share price stays flat. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.

Gullewa shrunk earnings per share by 8.5% last year.

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

Don't forget that the P/E ratio considers market capitalization. So it won't reflect the advantage of cash, or disadvantage of debt. 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.

Spending on growth might be good or bad a few years later, but the point is that the P/E ratio does not account for the option (or lack thereof).

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

With net cash of AU$1.4m, Gullewa has a very strong balance sheet, which may be important for its business. Having said that, at 26% of its market capitalization the cash hoard would contribute towards a higher P/E ratio.

The Verdict On Gullewa's P/E Ratio

Gullewa has a P/E of 5.3. That's below the average in the AU market, which is 18.2. The recent drop in earnings per share would almost certainly temper expectations, the healthy balance sheet means the company retains potential for future growth. If that occurs, the current low P/E could prove to be temporary. What we know for sure is that investors are becoming less uncomfortable about Gullewa's prospects, since they have pushed its P/E ratio from 3.9 to 5.3 over the last month. If you like to buy stocks that could be turnaround opportunities, then this one might be a candidate; but if you're more sensitive to price, 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 not as bad as the P/E ratio indicates, then the share price should increase as the market realizes this. We don't have analyst forecasts, but shareholders might want to examine this detailed historical graph of earnings, revenue and cash flow.

Of course you might be able to find a better stock than Gullewa. 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.