Riverstone Holdings (SGX:AP4) shareholders are no doubt pleased to see that the share price has had a great month, posting a 33% gain, recovering from prior weakness. However, the annual gain of 6.1% wasn't so impressive.
Assuming no other changes, a sharply higher share price makes a stock less attractive to potential buyers. 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. One way to gauge market expectations of a stock 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.
Does Riverstone Holdings Have A Relatively High Or Low P/E For Its Industry?
We can tell from its P/E ratio of 20.71 that sentiment around Riverstone Holdings isn't particularly high. If you look at the image below, you can see Riverstone Holdings has a lower P/E than the average (26.1) in the medical equipment industry classification.
This suggests that market participants think Riverstone Holdings 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. 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. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. 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.
Riverstone Holdings had pretty flat EPS growth in the last year. But it has grown its earnings per share by 15% per year over the last five years.
Remember: P/E Ratios Don't Consider The Balance Sheet
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. So it won't reflect the advantage of cash, or disadvantage of debt. In theory, a company can lower its future P/E ratio by using cash or debt to invest in 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).
Is Debt Impacting Riverstone Holdings's P/E?
Riverstone Holdings has net cash of RM112m. That should lead to a higher P/E than if it did have debt, because its strong balance sheets gives it more options.
The Verdict On Riverstone Holdings's P/E Ratio
Riverstone Holdings trades on a P/E ratio of 20.7, which is above its market average of 13.4. Earnings improved over the last year. And the healthy balance sheet means the company can sustain growth while the P/E suggests shareholders think it will. What is very clear is that the market has become significantly more optimistic about Riverstone Holdings over the last month, with the P/E ratio rising from 15.6 back then to 20.7 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 have an opportunity when market expectations about a stock are wrong. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. So this free report on the analyst consensus forecasts could help you make a master move on this stock.
Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.
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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