Of late the Prodigy Ventures (CVE:PGV) share price has softened like an ice cream in the sun, melting a full . But plenty of shareholders will still be smiling, given that the stock is up 16% over the last quarter. Zooming out, the recent drop wiped out a year's worth of gains, with the share price now back where it was a year ago.
Assuming no other changes, a sharply higher share price makes a stock less attractive to potential buyers. 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). 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.
Check out our latest analysis for Prodigy Ventures
Does Prodigy Ventures Have A Relatively High Or Low P/E For Its Industry?
We can tell from its P/E ratio of 62.96 that there is some investor optimism about Prodigy Ventures. You can see in the image below that the average P/E (31.1) for companies in the it industry is lower than Prodigy Ventures's P/E.
That means that the market expects Prodigy Ventures will outperform other companies in its industry.
How Growth Rates Impact P/E Ratios
When earnings fall, the 'E' decreases, over time. That means even if the current P/E is low, it will increase over time if the share price stays flat. A higher P/E should indicate the stock is expensive relative to others -- and that may encourage shareholders to sell.
Prodigy Ventures's earnings made like a rocket, taking off 118% last year. The cherry on top is that the five year growth rate was an impressive 18% per year. With that kind of growth rate we would generally expect a high P/E ratio. Regrettably, the longer term performance is poor, with EPS down -18% per year over 3 years. The market might expect further growth, but it isn't guaranteed. So investors should delve deeper. I like to check if company insiders have been buying or selling.
Remember: P/E Ratios Don't Consider The Balance Sheet
The 'Price' in P/E reflects the market capitalization of the company. That means it doesn't take debt or cash into account. 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.
Prodigy Ventures's Balance Sheet
Prodigy Ventures has net cash of CA$2.2m. 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 Prodigy Ventures's P/E Ratio
Prodigy Ventures's P/E is 63.0 which suggests the market is more focussed on the future opportunity rather than the current level of earnings. Its net cash position is the cherry on top of its superb EPS growth. To us, this is the sort of company that we would expect to carry an above average price tag (relative to earnings). Given Prodigy Ventures's P/E ratio has declined from 63.0 to 63.0 in the last month, we know for sure that the market is less confident about the business today, than it was back then. For those who don't like to trade against momentum, that could be a warning sign, but a contrarian investor might want to take a closer look.
Investors have an opportunity when market expectations about a stock are wrong. 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. Although we don't have analyst forecasts shareholders might want to examine this 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.
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.
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