To the annoyance of some shareholders, PagSeguro Digital (NYSE:PAGS) shares are down a considerable 38% in the last month. The recent drop has obliterated the annual return, with the share price now down 28% over that longer period.
All else being equal, a share price drop should make a stock more 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 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 PagSeguro Digital's P/E Ratio Compare To Its Peers?
PagSeguro Digital has a P/E ratio of 25.91. You can see in the image below that the average P/E (25.1) for companies in the it industry is roughly the same as PagSeguro Digital's P/E.
Its P/E ratio suggests that PagSeguro Digital shareholders think that in the future it will perform about the same as other companies in its industry classification. The company could surprise by performing better than average, in the future. Checking factors such as director buying and selling. could help you form your own view on if that will happen.
How Growth Rates Impact P/E Ratios
Earnings growth rates have a big influence on P/E ratios. When earnings grow, the 'E' increases, over time. That means unless the share price increases, the P/E will reduce in a few years. Then, a lower P/E should attract more buyers, pushing the share price up.
It's nice to see that PagSeguro Digital grew EPS by a stonking 45% in the last year. And earnings per share have improved by 111% annually, over the last five years. So we'd generally expect it to have a relatively high P/E ratio.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
Don't forget that the P/E ratio considers market capitalization. In other words, it does not consider any debt or cash that the company may have on the balance sheet. 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.
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).
How Does PagSeguro Digital's Debt Impact Its P/E Ratio?
Since PagSeguro Digital holds net cash of R$2.8b, it can spend on growth, justifying a higher P/E ratio than otherwise.
The Verdict On PagSeguro Digital's P/E Ratio
PagSeguro Digital has a P/E of 25.9. That's higher than the average in its market, which is 13.4. Its net cash position is the cherry on top of its superb EPS growth. So based on this analysis we'd expect PagSeguro Digital to have a high P/E ratio. What can be absolutely certain is that the market has become significantly less optimistic about PagSeguro Digital over the last month, with the P/E ratio falling from 41.7 back then to 25.9 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 PagSeguro Digital. 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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