To the annoyance of some shareholders, Anxian Yuan China Holdings (HKG:922) shares are down a considerable 32% in the last month. That drop has capped off a tough year for shareholders, with the share price down 56% in that time.
All else being equal, a share price drop should make a stock more 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). The implication here is that long term investors have an opportunity when expectations of a company are too low. One way to gauge market expectations of a stock 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.
Does Anxian Yuan China Holdings Have A Relatively High Or Low P/E For Its Industry?
We can tell from its P/E ratio of 7.90 that sentiment around Anxian Yuan China Holdings isn't particularly high. We can see in the image below that the average P/E (14.5) for companies in the consumer services industry is higher than Anxian Yuan China Holdings's P/E.
Its relatively low P/E ratio indicates that Anxian Yuan China Holdings shareholders think it will struggle to do as well as other companies in its industry classification. Many investors like to buy stocks when the market is pessimistic about their prospects. You should delve deeper. I like to check if company insiders have been buying or selling.
How Growth Rates Impact P/E Ratios
Companies that shrink earnings per share quickly will rapidly decrease the 'E' in the equation. Therefore, even if you pay a low multiple of earnings now, that multiple will become higher in the future. Then, a higher P/E might scare off shareholders, pushing the share price down.
Anxian Yuan China Holdings saw earnings per share decrease by 28% last year. But over the longer term (5 years) earnings per share have increased by 8.2%. And EPS is down 10.0% a year, over the last 3 years. This growth rate might warrant a low P/E ratio.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. In other words, it does not consider any debt or cash that the company may have on the balance sheet. The exact same company would hypothetically deserve a higher P/E ratio if it had a strong balance sheet, than if it had a weak one with lots of debt, because a cashed up company can spend on growth.
Such spending might be good or bad, overall, but the key point here is that you need to look at debt to understand the P/E ratio in context.
So What Does Anxian Yuan China Holdings's Balance Sheet Tell Us?
Net debt totals a substantial 113% of Anxian Yuan China Holdings's market cap. This level of debt justifies a relatively low P/E, so remain cognizant of the debt, if you're comparing it to other stocks.
The Bottom Line On Anxian Yuan China Holdings's P/E Ratio
Anxian Yuan China Holdings has a P/E of 7.9. That's below the average in the HK market, which is 10.1. When you consider that the company has significant debt, and didn't grow EPS last year, it isn't surprising that the market has muted expectations. What can be absolutely certain is that the market has become more pessimistic about Anxian Yuan China Holdings over the last month, with the P/E ratio falling from 11.5 back then to 7.9 today. For those who prefer invest in growth, this stock apparently offers limited promise, but the deep value investors may find the pessimism around this stock enticing.
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. Although we don't have analyst forecasts you could get a better understanding of its growth by checking out this more detailed historical graph of earnings, revenue and cash flow.
You might be able to find a better buy than Anxian Yuan China Holdings. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
If you spot an error that warrants correction, please contact the editor at email@example.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.
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