It’s great to see Korvest (ASX:KOV) shareholders have their patience rewarded with a 30% share price pop in the last month. And the full year gain of 31% isn’t too shabby, either!
All else being equal, a sharp share price increase should make a stock less attractive to potential investors. 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.
Does Korvest Have A Relatively High Or Low P/E For Its Industry?
Korvest’s P/E of 13.15 indicates relatively low sentiment towards the stock. We can see in the image below that the average P/E (18) for companies in the machinery industry is higher than Korvest’s P/E.
Its relatively low P/E ratio indicates that Korvest shareholders think it will struggle to do as well as other companies in its industry classification.
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. If earnings are growing quickly, then the ‘E’ in the equation will increase faster than it would otherwise. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
In the last year, Korvest grew EPS like Taylor Swift grew her fan base back in 2010; the 110% gain was both fast and well deserved. Even better, EPS is up 43% per year over three years. So you might say it really deserves to have an above-average P/E ratio. Unfortunately, earnings per share are down 17% a year, over 5 years.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. 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.
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.
Is Debt Impacting Korvest’s P/E?
Korvest has net cash of AU$3.4m. 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 Korvest’s P/E Ratio
Korvest trades on a P/E ratio of 13.1, which is below the AU market average of 16.2. Not only should the net cash position reduce risk, but the recent growth has been impressive. The below average P/E ratio suggests that market participants don’t believe the strong growth will continue. What is very clear is that the market has become significantly more optimistic about Korvest over the last month, with the P/E ratio rising from 10.1 back then to 13.1 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.
When the market is wrong about a stock, it gives savvy investors an opportunity. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. Although we don’t have analyst forecasts, you could get a better understanding of its growth by checking out this more detailed historical graph of earnings, revenue and cash flow.
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.
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.
If you spot an error that warrants correction, please contact the editor at 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. Simply Wall St has no position in the stocks mentioned. Thank you for reading.