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How Does Connexion Telematics's (ASX:CXZ) P/E Compare To Its Industry, After Its Big Share Price Gain?

The Connexion Telematics (ASX:CXZ) share price has done well in the last month, posting a gain of 50%. Zooming out, the annual gain of 275% knocks our socks off.

Assuming no other changes, a sharply higher share price makes a stock less attractive to potential buyers. 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. 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). A high P/E ratio means that investors have a high expectation about future growth, while a low P/E ratio means they have low expectations about future growth.

See our latest analysis for Connexion Telematics

How Does Connexion Telematics's P/E Ratio Compare To Its Peers?

We can tell from its P/E ratio of 52.91 that there is some investor optimism about Connexion Telematics. The image below shows that Connexion Telematics has a higher P/E than the average (34.5) P/E for companies in the software industry.

ASX:CXZ Price Estimation Relative to Market, October 24th 2019
ASX:CXZ Price Estimation Relative to Market, October 24th 2019

That means that the market expects Connexion Telematics will outperform other companies in its industry. Clearly the market expects growth, but it isn't guaranteed. So further research is always essential. I often monitor director buying and selling.

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. And in that case, the P/E ratio itself will drop rather quickly. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.

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Connexion Telematics saw earnings per share decrease by 23% last year.

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. So it won't reflect the advantage of cash, or disadvantage of debt. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.

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).

Is Debt Impacting Connexion Telematics's P/E?

Connexion Telematics has net cash of AU$939k. That should lead to a higher P/E than if it did have debt, because its strong balance sheets gives it more options.

The Verdict On Connexion Telematics's P/E Ratio

Connexion Telematics trades on a P/E ratio of 52.9, which is above its market average of 18.6. The recent drop in earnings per share might keep value investors away, but the healthy balance sheet means the company retains potential for future growth. If fails to eventuate, the current high P/E could prove to be temporary, as the share price falls. What is very clear is that the market has become significantly more optimistic about Connexion Telematics over the last month, with the P/E ratio rising from 35.3 back then to 52.9 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 should be looking to buy stocks that the market is wrong about. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. Although we don't have analyst forecasts 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 Connexion Telematics. 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).

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.