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A Rising Share Price Has Us Looking Closely At HUB24 Limited's (ASX:HUB) P/E Ratio

Simply Wall St

HUB24 (ASX:HUB) shareholders are no doubt pleased to see that the share price has bounced 34% in the last month alone, although it is still down 19% over the last quarter. But shareholders may not all be feeling jubilant, since the share price is still down 37% in the last year.

All else being equal, a sharp share price increase should make a stock less attractive to potential investors. 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 implies that investors have high expectations of what a company can achieve compared to a company with a low P/E ratio.

See our latest analysis for HUB24

Does HUB24 Have A Relatively High Or Low P/E For Its Industry?

We can tell from its P/E ratio of 57.42 that there is some investor optimism about HUB24. As you can see below, HUB24 has a much higher P/E than the average company (15.3) in the capital markets industry.

ASX:HUB Price Estimation Relative to Market April 11th 2020
ASX:HUB Price Estimation Relative to Market April 11th 2020

HUB24's P/E tells us that market participants think the company will perform better than its industry peers, going forward. Shareholders are clearly optimistic, but the future is always uncertain. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.

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. 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. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.

Most would be impressed by HUB24 earnings growth of 20% in the last year. And earnings per share have improved by 63% annually, over the last three years. So one might expect an above average P/E ratio.

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. 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.

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.

So What Does HUB24's Balance Sheet Tell Us?

The extra options and safety that comes with HUB24's AU$22m net cash position means that it deserves a higher P/E than it would if it had a lot of net debt.

The Verdict On HUB24's P/E Ratio

With a P/E ratio of 57.4, HUB24 is expected to grow earnings very strongly in the years to come. Its net cash position supports a higher P/E ratio, as does its solid recent earnings growth. So it is not surprising the market is probably extrapolating recent growth well into the future, reflected in the relatively high P/E ratio. What is very clear is that the market has become significantly more optimistic about HUB24 over the last month, with the P/E ratio rising from 42.8 back then to 57.4 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 should be looking to buy stocks that the market is wrong about. People often underestimate remarkable growth -- so investors can make money when fast growth is not fully appreciated. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.

You might be able to find a better buy than HUB24. 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.