A Rising Share Price Has Us Looking Closely At NVIDIA Corporation's (NASDAQ:NVDA) P/E Ratio

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). Investors have optimistic expectations of companies with higher P/E ratios, compared to companies with lower P/E ratios.

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content=" See our latest analysis for NVIDIA ” data-reactid=”21″>See our latest analysis for NVIDIA

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

We can tell from its P/E ratio of 61.85 that there is some investor optimism about NVIDIA. You can see in the image below that the average P/E (29.1) for companies in the semiconductor industry is lower than NVIDIA’s P/E.

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<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="That means that the market expects NVIDIA will outperform other companies in its industry. 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.” data-reactid=”36″>That means that the market expects NVIDIA will outperform other companies in its industry. 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

Probably the most important factor in determining what P/E a company trades on is the earnings growth. Earnings growth means that in the future the ‘E’ will be higher. That means unless the share price increases, the P/E will reduce in a few years. A lower P/E should indicate the stock is cheap relative to others — and that may attract buyers.

NVIDIA’s earnings per share fell by 33% in the last twelve months. But it has grown its earnings per share by 32% per year over the last five years.

Don’t Forget: The P/E Does Not Account For Debt or Bank Deposits

It’s important to note that the P/E ratio considers the market capitalization, not the enterprise value. In other words, it does not consider any debt or cash that the company may have on the balance sheet. 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).

How Does NVIDIA’s Debt Impact Its P/E Ratio?

The extra options and safety that comes with NVIDIA’s US$8.9b net cash position means that it deserves a higher P/E than it would if it had a lot of net debt.

The Verdict On NVIDIA’s P/E Ratio

NVIDIA’s P/E is 61.8 which suggests the market is more focussed on the future opportunity rather than the current level of earnings. The recent drop in earnings per share would make some investors cautious, 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 NVIDIA recently, since they have pushed its P/E ratio from 42.8 to 61.8 over the last month. 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.