Unfortunately for some shareholders, the Paylocity Holding (NASDAQ:PCTY) share price has dived 47% in the last thirty days. The recent drop has obliterated the annual return, with the share price now down 13% over that longer period.
All else being equal, a share price drop should make a stock more 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 long term investors have an opportunity when expectations of a company are too low. 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.
How Does Paylocity Holding's P/E Ratio Compare To Its Peers?
Paylocity Holding's P/E of 72.34 indicates some degree of optimism towards the stock. As you can see below, Paylocity Holding has a higher P/E than the average company (32.5) in the software industry.
That means that the market expects Paylocity Holding will outperform other companies in its industry. The market is optimistic about the future, but that doesn't guarantee future growth. So investors 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. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. Then, a lower P/E should attract more buyers, pushing the share price up.
Paylocity Holding's earnings per share grew by 7.5% in the last twelve months.
Remember: P/E Ratios Don't Consider The Balance Sheet
The 'Price' in P/E reflects the market capitalization of the company. That means it doesn't take debt or cash into account. 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.
While growth expenditure doesn't always pay off, the point is that it is a good option to have; but one that the P/E ratio ignores.
So What Does Paylocity Holding's Balance Sheet Tell Us?
Paylocity Holding has net cash of US$146m. 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 Paylocity Holding's P/E Ratio
With a P/E ratio of 72.3, Paylocity Holding is expected to grow earnings very strongly in the years to come. 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 can be absolutely certain is that the market has become significantly less optimistic about Paylocity Holding over the last month, with the P/E ratio falling from 136.1 back then to 72.3 today. For those who prefer to invest with the flow of momentum, that might be a bad sign, but for a contrarian, it may signal opportunity.
Investors should be looking to buy stocks that the market is wrong about. 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 visual report on analyst forecasts could hold the key to an excellent investment decision.
You might be able to find a better buy than Paylocity Holding. 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 email@example.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.
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