Hot Money Monday: Why a high P/E ratio could still be a smart stock pick

A high P/E ratio might be justified by future growth potential, while a low P/E doesn’t always mean a bargain.

High P/E may be justified by future growth potential. Pic: Getty Images

• P/E Ratio reveals if shares are cheap or expensive

• High P/E may be justified by future growth potential

• And low P/E doesn’t always mean a bargain 

The Price/Earnings (P/E) ratio is a simple way to gauge if a company’s shares are pricey or a bargain.

It’s calculated by dividing the share price by the company’s earnings per share.

For instance, if a share price is $10 and the company earned $1 per share, the P/E ratio would be 10, showing you’re paying $10 for every dollar of earnings.

Typically, the P/E ratio for the Australian market hovers around 15, but it can vary.

A lower P/E ratio often means a stock is cheaper, as you’re paying less for each dollar of earnings. However, this doesn’t paint the full picture, because investors care more about a company’s future earnings rather than just its past.

On the other hand, a high P/E might seem steep now, but if the company’s earnings are expected to grow it could turn out to be a good deal.

Also, be wary of earnings figures skewed by one-off gains or losses, as they might not reflect the company’s regular profitability.

High P/E doesn't always mean stock is expensive

The problem with P/E ratios is, they mostly look at past performance, not future potential.

So, a stock that seems expensive now based on past earnings could actually be a good deal if future earnings rise.

This serves as a reminder what truly makes a share valuable: it’s all about future cash flows, not just past performance.

For instance, if a company is expected to grow its earnings significantly in the future, a high P/E ratio might be justified.

Companies with a unique product, technology, or business model that gives them a strong competitive edge can also justify a higher P/E ratio.

Some companies with high P/E ratios are indeed very profitable, with strong margins and efficient operations.

And those in emerging sectors or benefiting from macro trends might have higher valuations that reflect their future potential.

“A high PE ratio might suggest that investors expect a high level of earnings in the future, and that growth will be strong,” said a note out of IG.

“The share price has risen faster than earnings, on expectations of an improvement in performance.”

ASX stocks with some of the highest P/E Ratios

Code	Name	P/E Ratio
SQ2	Block Inc.	101.32
IGO	IGO	100.27
MP1	Megaport	98.21
RPL	Regal Partners	94.99
BGA	Bega Cheese	93.78
MAT	Matsa Resources	93.33
HLS	Healius	93.14
GDC	Global Data Centre	90.23
EVT	EVT	88.35
STX	Strike Energy	88.1
NAN	Nanosonics	87.68
DUG	DUG Technology	86.9
AD8	Audinate Group	85.11
KPG	Kelly Partners	79.67
EOL	Energy One	77
HAW	Hawthorn Resources	76.25
KGN	Kogan.com	76.23
CVW	Clearview Wealth	73.33
WLE	WAM Leaders	71.75
ERD	EROAD	70.86

Megaport (ASX:MP1)

Megaport’s share price has plunged 30% over the past month on the back of some weak guidance.

But despite this significant fall, Megaport's P/E ratio still stands at around 98x, which is pretty high.

Its price-to-sales ratio also hovers around 6x, which is high compared to nearly half of Australia's IT sector, where many companies have ratios below 1.5x.

This suggests that Megaport might not be a top pick for investors looking at value based ratios, but it’s worth investigating further to understand the reasons behind its elevated ratio.

The company is set to benefit as demand for data centre facilities soars with the rise of AI. Megaport’s services, which facilitate fast and flexible connectivity between these data centres, are positioned to capture growth in this booming sector.

Bega Cheese (ASX:BGA)

Bega Cheese reported a strong year for its branded segment, which includes cheese and dairy products sold under the Bega name, with profits rising significantly despite a tough market.

Its total revenue grew to over $3.5 billion in FY24, with a 6% increase in branded revenue making up a big chunk of this.

During the year, Bega has made strides in cost efficiencies and integrating recent acquisitions.

Bega's high P/E ratio reflects investors' confidence in the company's future growth, particularly from its successful branded segment and ongoing improvements.

The strong cash flow and reduced debt might also be supporting this optimistic outlook.

Kogan.com (ASX:KGN)

Kogan.com reported a strong turnaround for FY24, bouncing back to profitability after a tough couple of years.

The company saw its revenue drop slightly but boosted its gross profit and margins, thanks to better management and growth in its loyalty programs.

Despite the overall revenue decline, Kogan's focus on high-margin platform-based sales and a loyal customer base helped it achieve significant improvements in its financial metrics.

Kogan's high P/E ratio might be reflecting the market’s expectation of future growth.

Investors are willing to pay a premium for its shares now, hoping that the company's strategic changes and growth in customer loyalty will lead to greater profits down the track.

ERoad (ASX:ERD)

ERoad specialises in fleet management and transport technology. The company provides software and hardware solutions that help businesses track and manage their vehicles and equipment.

ERoad has just landed a major contract with its biggest Australasian customer yet, though it can't name them just yet.

The deal covers at least 5,000 units for the customer's Australian fleet and up to 6,000 units for their New Zealand fleet, with a three-year term and a potential two-year extension.

This kind of big win boosts ERoad’s future revenue prospects, which is might be why its P/E ratio is high—investors are betting on more significant growth down the line.

This story does not constitute financial product advice. You should consider obtaining independent advice before making any financial decision.

Originally published as Hot Money Monday: Why a high P/E ratio could still be a smart stock pick