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When we invest, we're generally looking for stocks that outperform the market average. Buying under-rated businesses is one path to excess returns. For example, the ReadyTech Holdings Limited (ASX:RDY) share price is up 61% in the last 5 years, clearly besting the market return of around 22% (ignoring dividends).
Now it's worth having a look at the company's fundamentals too, because that will help us determine if the long term shareholder return has matched the performance of the underlying business.
View our latest analysis for ReadyTech Holdings
In his essay The Superinvestors of Graham-and-Doddsville Warren Buffett described how share prices do not always rationally reflect the value of a business. One way to examine how market sentiment has changed over time is to look at the interaction between a company's share price and its earnings per share (EPS).
During the five years of share price growth, ReadyTech Holdings moved from a loss to profitability. That would generally be considered a positive, so we'd hope to see the share price to rise. Given that the company made a profit three years ago, but not five years ago, it is worth looking at the share price returns over the last three years, too. We can see that the ReadyTech Holdings share price is down 25% in the last three years. Meanwhile, EPS is up 24% per year. It would appear there's a real mismatch between the increasing EPS and the share price, which has declined -9% a year for three years.
You can see how EPS has changed over time in the image below (click on the chart to see the exact values).
Before buying or selling a stock, we always recommend a close examination of historic growth trends, available here.
A Different Perspective
While the broader market gained around 23% in the last year, ReadyTech Holdings shareholders lost 17%. However, keep in mind that even the best stocks will sometimes underperform the market over a twelve month period. Longer term investors wouldn't be so upset, since they would have made 10%, each year, over five years. If the fundamental data continues to indicate long term sustainable growth, the current sell-off could be an opportunity worth considering. It's always interesting to track share price performance over the longer term. But to understand ReadyTech Holdings better, we need to consider many other factors. Consider for instance, the ever-present spectre of investment risk. We've identified 1 warning sign with ReadyTech Holdings , and understanding them should be part of your investment process.