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

Simply Wall St

Those holding Jumbo Interactive (ASX:JIN) shares must be pleased that the share price has rebounded 35% in the last thirty days. But unfortunately, the stock is still down by 28% over a quarter. But shareholders may not all be feeling jubilant, since the share price is still down 33% in the last year.

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. 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.

View our latest analysis for Jumbo Interactive

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

Jumbo Interactive's P/E of 24.82 indicates some degree of optimism towards the stock. You can see in the image below that the average P/E (17.7) for companies in the hospitality industry is lower than Jumbo Interactive's P/E.

ASX:JIN Price Estimation Relative to Market April 12th 2020
ASX:JIN Price Estimation Relative to Market April 12th 2020

That means that the market expects Jumbo Interactive will outperform other companies in its industry. Shareholders are clearly optimistic, but the future is always uncertain. 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. That's because companies that grow earnings per share quickly will rapidly increase the 'E' in the equation. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.

It's nice to see that Jumbo Interactive grew EPS by a stonking 33% in the last year. And earnings per share have improved by 64% annually, over the last five years. So we'd generally expect it to have a relatively high P/E ratio.

A Limitation: P/E Ratios Ignore Debt and Cash In The Bank

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. Theoretically, a business can improve its earnings (and produce a lower P/E in the future) by investing in growth. That means taking on debt (or spending its cash).

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.

Jumbo Interactive's Balance Sheet

Jumbo Interactive has net cash of AU$71m. This is fairly high at 10% 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 Verdict On Jumbo Interactive's P/E Ratio

Jumbo Interactive trades on a P/E ratio of 24.8, which is above its market average of 13.8. The excess cash it carries is the gravy on top its fast EPS growth. To us, this is the sort of company that we would expect to carry an above average price tag (relative to earnings). What is very clear is that the market has become significantly more optimistic about Jumbo Interactive over the last month, with the P/E ratio rising from 18.3 back then to 24.8 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 should be looking to buy stocks that the market is wrong about. 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. So this free report on the analyst consensus forecasts could help you make a master move on this stock.

But note: Jumbo Interactive may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).

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.