JCurve Solutions (ASX:JCS) shares have had a really impressive month, gaining 32%, after some slippage. And the full year gain of 27% isn't too shabby, either!
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 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.
Does JCurve Solutions Have A Relatively High Or Low P/E For Its Industry?
We can tell from its P/E ratio of 32.01 that sentiment around JCurve Solutions isn't particularly high. We can see in the image below that the average P/E (37.5) for companies in the software industry is higher than JCurve Solutions's P/E.
This suggests that market participants think JCurve Solutions will underperform other companies in its industry. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. You 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. That's because companies that grow earnings per share quickly will rapidly increase the 'E' in the equation. That means even if the current P/E is high, it will reduce over time if the share price stays flat. And as that P/E ratio drops, the company will look cheap, unless its share price increases.
JCurve Solutions saw earnings per share decrease by 60% last year.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
The 'Price' in P/E reflects the market capitalization of the company. 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.
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).
Is Debt Impacting JCurve Solutions's P/E?
With net cash of AU$5.0m, JCurve Solutions has a very strong balance sheet, which may be important for its business. Having said that, at 46% of its market capitalization the cash hoard would contribute towards a higher P/E ratio.
The Verdict On JCurve Solutions's P/E Ratio
JCurve Solutions trades on a P/E ratio of 32.0, which is above its market average of 18.7. Falling earnings per share is probably keeping traditional value investors away, but the net cash position means the company has time to improve: and the high P/E suggests the market thinks it will. What is very clear is that the market has become significantly more optimistic about JCurve Solutions over the last month, with the P/E ratio rising from 24.2 back then to 32.0 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.
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 could get a better understanding of its growth by checking out this more detailed historical graph of earnings, revenue and cash flow.
Of course you might be able to find a better stock than JCurve Solutions. So you may wish to see this free collection of other companies that have grown earnings strongly.
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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.
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