Home / Networking / Despite Its High P/E Ratio, Is HMS Networks AB (publ) (STO:HMS) Still Undervalued? – Simply Wall St

Despite Its High P/E Ratio, Is HMS Networks AB (publ) (STO:HMS) Still Undervalued? – Simply Wall St

The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We’ll show how you can use HMS Networks AB (publ)’s (STO:HMS) P/E ratio to inform your assessment of the investment opportunity. What is HMS Networks’s P/E ratio? Well, based on the last twelve months it is 39.12. That corresponds to an earnings yield of approximately 2.6%.

View our latest analysis for HMS Networks

How Do You Calculate A P/E Ratio?

The formula for price to earnings is:

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

Or for HMS Networks:

P/E of 39.12 = SEK154.8 ÷ SEK3.96 (Based on the year to June 2019.)

Is A High P/E Ratio Good?

The higher the P/E ratio, the higher the price tag of a business, relative to its trailing earnings. That isn’t necessarily good or bad, but a high P/E implies relatively high expectations of what a company can achieve in the future.

How Does HMS Networks’s P/E Ratio Compare To Its Peers?

We can get an indication of market expectations by looking at the P/E ratio. The image below shows that HMS Networks has a higher P/E than the average (22.5) P/E for companies in the communications industry.

OM:HMS Price Estimation Relative to Market, August 11th 2019
OM:HMS Price Estimation Relative to Market, August 11th 2019

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

How Growth Rates Impact P/E Ratios

Earnings growth rates have a big influence on P/E ratios. When earnings grow, the ‘E’ increases, over time. That means unless the share price increases, the P/E will reduce in a few years. Then, a lower P/E should attract more buyers, pushing the share price up.

HMS Networks increased earnings per share by a whopping 30% last year. And earnings per share have improved by 24% annually, over the last five years. 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

One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. Thus, the metric does not reflect cash or debt held by the company. 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 spending might be good or bad, overall, but the key point here is that you need to look at debt to understand the P/E ratio in context.

HMS Networks’s Balance Sheet

Net debt totals just 5.6% of HMS Networks’s market cap. So it doesn’t have as many options as it would with net cash, but its debt would not have much of an impact on its P/E ratio.

The Verdict On HMS Networks’s P/E Ratio

HMS Networks’s P/E is 39.1 which is above average (16.1) 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.

Investors should be looking to buy stocks that the market is wrong about. As value investor Benjamin Graham famously said, ‘In the short run, the market is a voting machine but in the long run, it is a weighing machine.’ So this free report on the analyst consensus forecasts could help you make a master move on this stock.

But note: HMS Networks 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).

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.

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