PagSeguro Digital (NYSE:PAGS) shareholders are no doubt pleased to see that the share price has had a great month, posting a 31% gain, recovering from prior weakness. But that gain wasn’t enough to make shareholders whole, as the share price is still down 7.7% in the last year.
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. One way to gauge market expectations of a stock 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’s P/E of 38.57 indicates some degree of optimism towards the stock. You can see in the image below that the average P/E (26.3) for companies in the it industry is lower than PagSeguro Digital’s P/E.
That means that the market expects PagSeguro Digital will outperform other companies in its industry. Shareholders are clearly optimistic, but the future is always uncertain. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.
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. That’s because companies that grow earnings per share quickly will rapidly increase the ‘E’ in the equation. And in that case, the P/E ratio itself will drop rather quickly. A lower P/E should indicate the stock is cheap relative to others — and that may attract buyers.
PagSeguro Digital increased earnings per share by a whopping 45% last year. And it has bolstered its earnings per share by 111% per year over the last five years. With that performance, I would expect it to have an above average P/E ratio.
Remember: P/E Ratios Don’t Consider The Balance Sheet
The ‘Price’ in P/E reflects the market capitalization of the company. Thus, the metric does not reflect cash or debt held by the company. 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.
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.
So What Does PagSeguro Digital’s Balance Sheet Tell Us?
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 trades on a P/E ratio of 38.6, which is above its market average of 15.6. 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 is very clear is that the market has become significantly more optimistic about PagSeguro Digital over the last month, with the P/E ratio rising from 29.4 back then to 38.6 today. 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. 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 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 be able to find a better stock than PagSeguro Digital. So you may wish to see this free collection of other companies that have grown earnings strongly.
Love or hate this article? Concerned about the content? Get in touch with us directly. Alternatively, email firstname.lastname@example.org.
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. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned. Thank you for reading.