A Rising Share Price Has Us Looking Closely At Thermal Energy International Inc.’s (CVE:TMG) P/E Ratio

Thermal Energy International (CVE:TMG) shareholders are no doubt pleased to see that the share price has had a great month, posting a 43% gain, recovering from prior weakness. The full year gain of 25% is pretty reasonable, too.

Assuming no other changes, a sharply higher share price makes a stock less attractive to potential buyers. 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 deep value investors might steer clear when expectations of a company are too high. 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.

Check out our latest analysis for Thermal Energy International

How Does Thermal Energy International’s P/E Ratio Compare To Its Peers?

Thermal Energy International’s P/E of 44.46 indicates some degree of optimism towards the stock. The image below shows that Thermal Energy International has a higher P/E than the average (23.8) P/E for companies in the machinery industry.

TSXV:TMG Price Estimation Relative to Market, February 4th 2020
TSXV:TMG Price Estimation Relative to Market, February 4th 2020

Its relatively high P/E ratio indicates that Thermal Energy International shareholders think it will perform better than other companies in its industry classification. Clearly the market expects growth, but it isn’t guaranteed. So further research is always essential. I often monitor director buying and selling.

How Growth Rates Impact P/E Ratios

When earnings fall, the ‘E’ decreases, over time. That means unless the share price falls, the P/E will increase in a few years. So while a stock may look cheap based on past earnings, it could be expensive based on future earnings.

Thermal Energy International saw earnings per share decrease by 38% last year. And it has shrunk its earnings per share by 23% per year over the last three years. This might lead to low expectations.

Remember: P/E Ratios Don’t Consider The Balance Sheet

Don’t forget that the P/E ratio considers market capitalization. Thus, the metric does not reflect cash or debt held by the company. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.

Such spending might be good or bad, overall, but the key point here is that you need to look at debt to understand the P/E ratio in context.

Thermal Energy International’s Balance Sheet

Thermal Energy International has net cash of CA$2.2m. This is fairly high at 15% of its market capitalization. That might mean balance sheet strength is important to the business, but should also help push the P/E a bit higher than it would otherwise be.

The Bottom Line On Thermal Energy International’s P/E Ratio

Thermal Energy International trades on a P/E ratio of 44.5, which is above its market average of 15.5. The recent drop in earnings per share would make some investors cautious, but the net cash position means the company has time to improve: and the high P/E suggests the market thinks it will. What we know for sure is that investors have become much more excited about Thermal Energy International recently, since they have pushed its P/E ratio from 31.1 to 44.5 over the last month. For those who prefer to invest with the flow of momentum, that might mean it’s time to put the stock on a watchlist, or research it. But the contrarian may see it as a missed 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. We don’t have analyst forecasts, but you could get a better understanding of its growth by checking out this more detailed historical graph of earnings, revenue and cash flow.

You might be able to find a better buy than Thermal Energy International. 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 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.