Those holding Kogan.com (ASX:KGN) shares must be pleased that the share price has rebounded 36% in the last thirty days. But unfortunately, the stock is still down by 19% over a quarter. Looking back a bit further, we're also happy to report the stock is up 52% in the last year.
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). Investors have optimistic expectations of companies with higher P/E ratios, compared to companies with lower P/E ratios.
Does Kogan.com Have A Relatively High Or Low P/E For Its Industry?
Kogan.com's P/E of 29.98 indicates some degree of optimism towards the stock. As you can see below, Kogan.com has a higher P/E than the average company (19.2) in the online retail industry.
That means that the market expects Kogan.com will outperform other companies in its industry. Shareholders are clearly optimistic, but the future is always uncertain. So investors should delve deeper. I like to check if company insiders have been buying or selling.
How Growth Rates Impact P/E Ratios
Probably the most important factor in determining what P/E a company trades on is the earnings growth. 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.
It's nice to see that Kogan.com grew EPS by a stonking 42% in the last year. And earnings per share have improved by 212% annually, over the last three years. With that performance, I would expect it to have an above average P/E ratio.
Remember: P/E Ratios Don't Consider The Balance Sheet
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. That means it doesn't take debt or cash into account. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
Spending on growth might be good or bad a few years later, but the point is that the P/E ratio does not account for the option (or lack thereof).
So What Does Kogan.com's Balance Sheet Tell Us?
Since Kogan.com holds net cash of AU$34m, it can spend on growth, justifying a higher P/E ratio than otherwise.
The Verdict On Kogan.com's P/E Ratio
Kogan.com's P/E is 30.0 which is above average (13.4) in its market. The excess cash it carries is the gravy on top its fast EPS growth. So based on this analysis we'd expect Kogan.com to have a high P/E ratio. What is very clear is that the market has become significantly more optimistic about Kogan.com over the last month, with the P/E ratio rising from 22.0 back then to 30.0 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 the reality for a company is better than it expects, you can make money by buying and holding for the long term. 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.
But note: Kogan.com may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
If you spot an error that warrants correction, please contact the editor at email@example.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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