Does Alkemy S.p.A.'s (BIT:ALK) P/E Ratio Signal A Buying Opportunity?

Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll look at Alkemy S.p.A.'s (BIT:ALK) P/E ratio and reflect on what it tells us about the company's share price. Alkemy has a price to earnings ratio of 16.23, based on the last twelve months. That is equivalent to an earnings yield of about 6.2%.

See our latest analysis for Alkemy

How Do You Calculate A P/E Ratio?

The formula for P/E is:

Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)

Or for Alkemy:

P/E of 16.23 = €10.80 ÷ €0.67 (Based on the trailing twelve months to June 2019.)

Is A High Price-to-Earnings Ratio Good?

The higher the P/E ratio, the higher the price tag of a business, relative to its trailing earnings. That isn't a good or a bad thing on its own, but a high P/E means that buyers have a higher opinion of the business's prospects, relative to stocks with a lower P/E.

Does Alkemy Have A Relatively High Or Low P/E For Its Industry?

One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. The image below shows that Alkemy has a lower P/E than the average (19.0) P/E for companies in the professional services industry.

Its relatively low P/E ratio indicates that Alkemy shareholders think it will struggle to do as well as other companies in its industry classification. Many investors like to buy stocks when the market is pessimistic about their prospects. 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

If earnings fall then in the future the 'E' will be lower. That means unless the share price falls, the P/E will increase in a few years. A higher P/E should indicate the stock is expensive relative to others -- and that may encourage shareholders to sell.

In the last year, Alkemy grew EPS like Taylor Swift grew her fan base back in 2010; the 105% gain was both fast and well deserved. Unfortunately, earnings per share are down 36% a year, over 3 years.

Don't Forget: The P/E Does Not Account For Debt or Bank Deposits

It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. That means it doesn't take debt or cash into account. 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 Alkemy's Balance Sheet Tell Us?

Alkemy has net cash of €4.4m. That should lead to a higher P/E than if it did have debt, because its strong balance sheets gives it more options.

The Bottom Line On Alkemy's P/E Ratio

Alkemy trades on a P/E ratio of 16.2, which is fairly close to the IT market average of 17.4. Its net cash position is the cherry on top of its superb EPS growth. So at a glance we're a bit surprised that Alkemy does not have a higher P/E ratio.

Investors should be looking to buy stocks that the market is wrong about. If the reality for a company is not as bad as the P/E ratio indicates, then the share price should increase as the market realizes this. 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 Alkemy. So you may wish to see this free collection of other companies that have grown earnings strongly.

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 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. Thank you for reading.