To the annoyance of some shareholders, K3 Capital Group (LON:K3C) shares are down a considerable 30% in the last month. Even longer term holders have taken a real hit with the stock declining 22% 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. 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). Investors have optimistic expectations of companies with higher P/E ratios, compared to companies with lower P/E ratios.
Does K3 Capital Group Have A Relatively High Or Low P/E For Its Industry?
K3 Capital Group has a P/E ratio of 14.74. As you can see below K3 Capital Group has a P/E ratio that is fairly close for the average for the professional services industry, which is 15.1.
K3 Capital Group’s P/E tells us that market participants think its prospects are roughly in line with its industry. The company could surprise by performing better than average, in the future. I would further inform my view by checking insider buying and selling., among other things.
How Growth Rates Impact P/E Ratios
If earnings fall then in the future the ‘E’ will be lower. That means even if the current P/E is low, it will increase over time if the share price stays flat. So while a stock may look cheap based on past earnings, it could be expensive based on future earnings.
K3 Capital Group saw earnings per share decrease by 29% last year. And it has shrunk its earnings per share by 40% per year over the last five years. This growth rate might warrant a below average P/E ratio.
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. Theoretically, a business can improve its earnings (and produce a lower P/E in the future) by investing in growth. That means taking on debt (or spending its cash).
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 K3 Capital Group’s P/E?
With net cash of UK£6.8m, K3 Capital Group has a very strong balance sheet, which may be important for its business. Having said that, at 11% of its market capitalization the cash hoard would contribute towards a higher P/E ratio.
The Verdict On K3 Capital Group’s P/E Ratio
K3 Capital Group has a P/E of 14.7. That’s higher than the average in its market, which is 12.5. 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 can be absolutely certain is that the market has become significantly less optimistic about K3 Capital Group over the last month, with the P/E ratio falling from 21.1 back then to 14.7 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 have an opportunity when market expectations about a stock are wrong. People often underestimate remarkable growth — so investors can make money when fast growth is not fully appreciated. So this free visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.
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 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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