A Rising Share Price Has Us Looking Closely At Sinch AB (publ)'s (STO:SINCH) P/E Ratio

Simply Wall St

It's really great to see that even after a strong run, Sinch (STO:SINCH) shares have been powering on, with a gain of 31% in the last thirty days. Zooming out, the annual gain of 119% knocks our socks off.

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). So some would prefer to hold off buying when there is a lot of optimism towards a stock. 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). 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 Sinch

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

Sinch's P/E is 42.93. You can see in the image below that the average P/E (42.6) for companies in the software industry is roughly the same as Sinch's P/E.

OM:SINCH Price Estimation Relative to Market, December 2nd 2019

Its P/E ratio suggests that Sinch shareholders think that in the future it will perform about the same as other companies in its industry classification. So if Sinch actually outperforms its peers going forward, that should be a positive for the share price. Checking factors such as director buying and selling. could help you form your own view on if that will happen.

How Growth Rates Impact P/E Ratios

Earnings growth rates have a big influence on P/E ratios. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. That means unless the share price increases, the P/E will reduce in a few years. And as that P/E ratio drops, the company will look cheap, unless its share price increases.

In the last year, Sinch grew EPS like Taylor Swift grew her fan base back in 2010; the 70% gain was both fast and well deserved. The sweetener is that the annual five year growth rate of 37% is also impressive. So I'd be surprised if the P/E ratio was not above average.

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

Don't forget that the P/E ratio considers market capitalization. So it won't reflect the advantage of cash, or disadvantage of debt. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.

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.

How Does Sinch's Debt Impact Its P/E Ratio?

Sinch's net debt is 3.7% of its market cap. It would probably trade on a higher P/E ratio if it had a lot of cash, but I doubt it is having a big impact.

The Verdict On Sinch's P/E Ratio

Sinch's P/E is 42.9 which is above average (18.5) in its market. Its debt levels do not imperil its balance sheet and its EPS growth is very healthy indeed. So to be frank we are not surprised it has a high P/E ratio. What is very clear is that the market has become significantly more optimistic about Sinch over the last month, with the P/E ratio rising from 32.8 back then to 42.9 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.

Investors have an opportunity when market expectations about a stock are wrong. People often underestimate remarkable growth -- so investors can make money when fast growth is not fully appreciated. So this free report on the analyst consensus forecasts could help you make a master move on this stock.

But note: Sinch 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 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.