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A Sliding Share Price Has Us Looking At Data#3 Limited's (ASX:DTL) P/E Ratio

Simply Wall St

Unfortunately for some shareholders, the Data#3 (ASX:DTL) share price has dived 33% in the last thirty days. Looking at the bigger picture, the stock is up 95% in the last year.

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). So, on certain occasions, long term focussed investors try to take advantage of pessimistic expectations to buy shares at a better price. 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 Data#3

How Does Data#3's P/E Ratio Compare To Its Peers?

Data#3 has a P/E ratio of 24.43. You can see in the image below that the average P/E (22.9) for companies in the it industry is roughly the same as Data#3's P/E.

ASX:DTL Price Estimation Relative to Market, March 12th 2020
ASX:DTL Price Estimation Relative to Market, March 12th 2020

That indicates that the market expects Data#3 will perform roughly in line with other companies in its industry. 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

Generally speaking the rate of earnings growth has a profound impact on a company's P/E multiple. Earnings growth means that in the future the 'E' will be higher. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. And as that P/E ratio drops, the company will look cheap, unless its share price increases.

It's great to see that Data#3 grew EPS by 18% in the last year. And it has bolstered its earnings per share by 19% per year over the last five years. With that performance, you might expect an above average P/E ratio.

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

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.

Is Debt Impacting Data#3's P/E?

Data#3 has net cash of AU$23m. 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 Data#3's P/E Ratio

Data#3 has a P/E of 24.4. That's higher than the average in its market, which is 15.9. Its net cash position supports a higher P/E ratio, as does its solid recent earnings growth. So it does not seem strange that the P/E is above average. What can be absolutely certain is that the market has become significantly less optimistic about Data#3 over the last month, with the P/E ratio falling from 36.3 back then to 24.4 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. 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 visual report on analyst forecasts could hold the key to an excellent investment decision.

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 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.