A Rising Share Price Has Us Looking Closely At Generic Sweden AB's (STO:GENI) P/E Ratio

Generic Sweden (STO:GENI) shares have continued recent momentum with a 39% gain in the last month alone. That's tops off a massive gain of 278% 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). 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.

Check out our latest analysis for Generic Sweden

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

We can tell from its P/E ratio of 36.18 that there is some investor optimism about Generic Sweden. The image below shows that Generic Sweden has a higher P/E than the average (20.1) P/E for companies in the it industry.

Its relatively high P/E ratio indicates that Generic Sweden shareholders think it will perform better than other companies in its industry classification. 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

Generally speaking the rate of earnings growth has a profound impact on a company's P/E multiple. When earnings grow, the 'E' increases, over time. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.

Notably, Generic Sweden grew EPS by a whopping 48% in the last year. And its annual EPS growth rate over 3 years is 29%. I'd therefore be a little surprised if its P/E ratio was not relatively high.

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

The 'Price' in P/E reflects the market capitalization of the company. That means it doesn't take debt or cash into account. Theoretically, a business can improve its earnings (and produce a lower P/E in the future) by investing in growth. That means taking on debt (or spending its cash).

Such expenditure might be good or bad, in the long term, but the point here is that the balance sheet is not reflected by this ratio.

Is Debt Impacting Generic Sweden's P/E?

The extra options and safety that comes with Generic Sweden's kr18m net cash position means that it deserves a higher P/E than it would if it had a lot of net debt.

The Bottom Line On Generic Sweden's P/E Ratio

Generic Sweden has a P/E of 36.2. That's higher than the average in its market, which is 19.8. The excess cash it carries is the gravy on top its fast EPS growth. To us, this is the sort of company that we would expect to carry an above average price tag (relative to earnings). What is very clear is that the market has become significantly more optimistic about Generic Sweden over the last month, with the P/E ratio rising from 26.0 back then to 36.2 today. 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.

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 report on the analyst consensus forecasts could help you make a master move on this stock.

Of course you might be able to find a better stock than Generic Sweden. So you may wish to see this free collection of other companies that have grown earnings strongly.

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.

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