Canada markets closed

A Rising Share Price Has Us Looking Closely At Thermal Energy International Inc.'s (CVE:TMG) P/E Ratio

Simply Wall St

Thermal Energy International (CVE:TMG) shareholders are no doubt pleased to see that the share price has had a great month, posting a 36% gain, recovering from prior weakness. The full year gain of 12% is pretty reasonable, too.

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). 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 Thermal Energy International

Does Thermal Energy International Have A Relatively High Or Low P/E For Its Industry?

Thermal Energy International's P/E of 42.49 indicates some degree of optimism towards the stock. The image below shows that Thermal Energy International has a higher P/E than the average (24.5) P/E for companies in the machinery industry.

TSXV:TMG Price Estimation Relative to Market, January 30th 2020

Thermal Energy International's P/E tells us that market participants think the company will perform better than its industry peers, going forward. 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

If earnings fall then in the future the 'E' will be lower. That means unless the share price falls, the P/E will increase in a few years. Then, a higher P/E might scare off shareholders, pushing the share price down.

Thermal Energy International shrunk earnings per share by 38% over the last year. And it has shrunk its earnings per share by 23% per year over the last three years. This might lead to low expectations.

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

The 'Price' in P/E reflects the market capitalization of the company. Thus, the metric does not reflect cash or debt held by the company. 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).

How Does Thermal Energy International's Debt Impact Its P/E Ratio?

With net cash of CA$2.2m, Thermal Energy International has a very strong balance sheet, which may be important for its business. Having said that, at 16% of its market capitalization the cash hoard would contribute towards a higher P/E ratio.

The Verdict On Thermal Energy International's P/E Ratio

Thermal Energy International trades on a P/E ratio of 42.5, which is above its market average of 15.6. Falling earnings per share is probably keeping traditional value investors away, but the relatively strong balance sheet will allow the company time to invest in growth. Clearly, the high P/E indicates shareholders think it will! What we know for sure is that investors have become much more excited about Thermal Energy International recently, since they have pushed its P/E ratio from 31.3 to 42.5 over the last month. 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. 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. We don't have analyst forecasts, but shareholders might want to examine this detailed historical graph of earnings, revenue and cash flow.

Of course you might be able to find a better stock than Thermal Energy International. 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.

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.