A Rising Share Price Has Us Looking Closely At Bauba Resources Limited's (JSE:BAU) P/E Ratio

Bauba Resources (JSE:BAU) shareholders are no doubt pleased to see that the share price has bounced 8.3% in the last month alone, although it is still down 32% over the last quarter. But shareholders may not all be feeling jubilant, since the share price is still down 49% 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). Investors have optimistic expectations of companies with higher P/E ratios, compared to companies with lower P/E ratios.

Check out our latest analysis for Bauba Resources

How Does Bauba Resources's P/E Ratio Compare To Its Peers?

Bauba Resources's P/E of 3.57 indicates relatively low sentiment towards the stock. The image below shows that Bauba Resources has a lower P/E than the average (16.5) P/E for companies in the metals and mining industry.

Bauba Resources's P/E tells us that market participants think it will not fare as well as its peers in the same industry. Since the market seems unimpressed with Bauba Resources, it's quite possible it could surprise on the upside. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and selling.

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. 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. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.

Bauba Resources's 117% EPS improvement over the last year was like bamboo growth after rain; rapid and impressive.

A Limitation: P/E Ratios Ignore Debt and Cash In The Bank

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. 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.

Bauba Resources's Balance Sheet

Since Bauba Resources holds net cash of SAR6.8m, it can spend on growth, justifying a higher P/E ratio than otherwise.

The Bottom Line On Bauba Resources's P/E Ratio

Bauba Resources trades on a P/E ratio of 3.6, which is below the ZA market average of 8.2. The net cash position gives plenty of options to the business, and the recent improvement in EPS is good to see. 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 less pessimistic about Bauba Resources over the last month, with the P/E ratio rising from 3.3 back then to 3.6 today. If you like to buy stocks that could be turnaround opportunities, then this one might be a candidate; but if you're more sensitive to price, then you may feel the opportunity has passed.

When the market is wrong about a stock, it gives savvy investors an opportunity. 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. We don't have analyst forecasts, but you could get a better understanding of its growth by checking out this more detailed historical graph of earnings, revenue and cash flow.

You might be able to find a better buy than Bauba Resources. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).

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.