It's really great to see that even after a strong run, Solid State (LON:SOLI) shares have been powering on, with a gain of 30% in the last thirty days. Zooming out, the annual gain of 115% knocks our socks off.
All else being equal, a sharp share price increase should make a stock less 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 some would prefer to hold off buying when there is a lot of optimism towards a stock. 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.
Does Solid State Have A Relatively High Or Low P/E For Its Industry?
Solid State's P/E of 14.67 indicates relatively low sentiment towards the stock. The image below shows that Solid State has a lower P/E than the average (21.5) P/E for companies in the electronic industry.
This suggests that market participants think Solid State will underperform other companies in its industry. Since the market seems unimpressed with Solid State, it's quite possible it could surprise on the upside. You should delve deeper. I like to check if company insiders have been buying or 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. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. And in that case, the P/E ratio itself will drop rather quickly. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
In the last year, Solid State grew EPS like Taylor Swift grew her fan base back in 2010; the 54% gain was both fast and well deserved. Having said that, the average EPS growth over the last three years wasn't so good, coming in at 13%.
Remember: P/E Ratios Don't Consider The Balance Sheet
It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. In other words, it does not consider any debt or cash that the company may have on the balance sheet. In theory, a company can lower its future P/E ratio by using cash or debt to invest in 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.
Solid State's Balance Sheet
Since Solid State holds net cash of UK£267k, it can spend on growth, justifying a higher P/E ratio than otherwise.
The Verdict On Solid State's P/E Ratio
Solid State's P/E is 14.7 which is below average (17.8) in the GB market. It grew its EPS nicely over the last year, and the healthy balance sheet implies there is more potential for growth. One might conclude that the market is a bit pessimistic, given the low P/E ratio. What we know for sure is that investors have become more excited about Solid State recently, since they have pushed its P/E ratio from 11.3 to 14.7 over the last month. 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. If the reality for a company is not as bad as the P/E ratio indicates, then the share price should increase as the market realizes this. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.
Of course you might be able to find a better stock than Solid State. So you may wish to see this free collection of other companies that have grown earnings strongly.
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.
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.