How Does NETGEAR’s (NASDAQ:NTGR) P/E Compare To Its Industry, After Its Big Share Price Gain?

NETGEAR (NASDAQ:NTGR) shareholders are no doubt pleased to see that the share price has had a great month, posting a 32% gain, recovering from prior weakness. But shareholders may not all be feeling jubilant, since the share price is still down 26% in the last year.

All else being equal, a sharp share price increase should make a stock less 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 some would prefer to hold off buying when there is a lot of optimism towards a stock. One way to gauge market expectations of a stock is to look at its Price to Earnings Ratio (PE Ratio). A high P/E ratio means that investors have a high expectation about future growth, while a low P/E ratio means they have low expectations about future growth.

View our latest analysis for NETGEAR

How Does NETGEAR’s P/E Ratio Compare To Its Peers?

NETGEAR’s P/E of 29.87 indicates some degree of optimism towards the stock. As you can see below, NETGEAR has a higher P/E than the average company (25.4) in the communications industry.

NasdaqGS:NTGR Price Estimation Relative to Market April 10th 2020
NasdaqGS:NTGR Price Estimation Relative to Market April 10th 2020

That means that the market expects NETGEAR will outperform other companies in its industry. The market is optimistic about the future, but that doesn’t guarantee future growth. 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. Then, a higher P/E might scare off shareholders, pushing the share price down.

In the last year, NETGEAR grew EPS like Taylor Swift grew her fan base back in 2010; the 52% gain was both fast and well deserved. The sweetener is that the annual five year growth rate of 28% is also impressive. So I’d be surprised if the P/E ratio was not above average. Regrettably, the longer term performance is poor, with EPS down -28% per year over 3 years.

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

The ‘Price’ in P/E reflects the market capitalization of the company. In other words, it does not consider any debt or cash that the company may have on the balance sheet. 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.

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.

How Does NETGEAR’s Debt Impact Its P/E Ratio?

NETGEAR has net cash of US$196m. This is fairly high at 27% 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 Verdict On NETGEAR’s P/E Ratio

NETGEAR trades on a P/E ratio of 29.9, which is above its market average of 13.6. The excess cash it carries is the gravy on top its fast EPS growth. So based on this analysis we’d expect NETGEAR to have a high P/E ratio. What we know for sure is that investors have become much more excited about NETGEAR recently, since they have pushed its P/E ratio from 22.6 to 29.9 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. 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 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.