Alpha Era International Holdings (HKG:8406) shares have had a really impressive month, gaining 31%, after some slippage. But shareholders may not all be feeling jubilant, since the share price is still down 15% in the last year.
Assuming no other changes, a sharply higher share price makes a stock less attractive to potential buyers. While the market sentiment towards a stock is very changeable, in the long run, the share price will tend to move in the same direction as earnings per share. 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.
How Does Alpha Era International Holdings's P/E Ratio Compare To Its Peers?
Alpha Era International Holdings's P/E of 3.81 indicates relatively low sentiment towards the stock. We can see in the image below that the average P/E (9.8) for companies in the leisure industry is higher than Alpha Era International Holdings's P/E.
Its relatively low P/E ratio indicates that Alpha Era International Holdings shareholders think it will struggle to do as well as other companies in its industry classification. Since the market seems unimpressed with Alpha Era International Holdings, it's quite possible it could surprise on the upside. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.
How Growth Rates Impact P/E Ratios
Generally speaking the rate of earnings growth has a profound impact on a company's P/E multiple. When earnings grow, the 'E' increases, over time. That means even if the current P/E is high, it will reduce over time if the share price stays flat. And as that P/E ratio drops, the company will look cheap, unless its share price increases.
Alpha Era International Holdings's earnings made like a rocket, taking off 421% last year. The sweetener is that the annual five year growth rate of 30% is also impressive. With that kind of growth rate we would generally expect a high P/E ratio.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
Don't forget that the P/E ratio considers market capitalization. So it won't reflect the advantage of cash, or disadvantage of debt. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.
While growth expenditure doesn't always pay off, the point is that it is a good option to have; but one that the P/E ratio ignores.
Is Debt Impacting Alpha Era International Holdings's P/E?
Alpha Era International Holdings has net cash of CN¥36m. This is fairly high at 42% of its market capitalization. That might mean balance sheet strength is important to the business, but should also help push the P/E a bit higher than it would otherwise be.
The Bottom Line On Alpha Era International Holdings's P/E Ratio
Alpha Era International Holdings trades on a P/E ratio of 3.8, which is below the HK market average of 10.3. Not only should the net cash position reduce risk, but the recent growth has been impressive. One might conclude that the market is a bit pessimistic, given the low P/E ratio. What we know for sure is that investors are becoming less uncomfortable about Alpha Era International Holdings's prospects, since they have pushed its P/E ratio from 2.9 to 3.8 over the last month. For those who like to invest in turnarounds, that might mean it's time to put the stock on a watchlist, or research it. But others might consider the opportunity to have passed.
When the market is wrong about a stock, it gives savvy investors an opportunity. 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 you might want to assess this data-rich visualization of earnings, revenue and cash flow.
But note: Alpha Era International Holdings 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).
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If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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.