Beijing Chunlizhengda Medical Instruments (HKG:1858) shares have continued recent momentum with a 31% gain in the last month alone. Zooming out, the stock's 328% gain in the last year is certainly splendiferous.
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). A high P/E ratio means that investors have a high expectation about future growth, while a low P/E ratio means they have low expectations about future growth.
How Does Beijing Chunlizhengda Medical Instruments's P/E Ratio Compare To Its Peers?
We can tell from its P/E ratio of 41.29 that there is some investor optimism about Beijing Chunlizhengda Medical Instruments. You can see in the image below that the average P/E (16.5) for companies in the medical equipment industry is lower than Beijing Chunlizhengda Medical Instruments's P/E.
Its relatively high P/E ratio indicates that Beijing Chunlizhengda Medical Instruments shareholders think it will perform better than other companies in its industry classification. Clearly the market expects growth, but it isn't guaranteed. So further research is always essential. I often monitor director buying and selling.
How Growth Rates Impact P/E Ratios
P/E ratios primarily reflect market expectations around earnings growth rates. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. That means even if the current P/E is high, it will reduce over time if the share price stays flat. Then, a lower P/E should attract more buyers, pushing the share price up.
In the last year, Beijing Chunlizhengda Medical Instruments grew EPS like Taylor Swift grew her fan base back in 2010; the 99% gain was both fast and well deserved. The sweetener is that the annual five year growth rate of 26% 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. 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 Beijing Chunlizhengda Medical Instruments's Debt Impact Its P/E Ratio?
The extra options and safety that comes with Beijing Chunlizhengda Medical Instruments's CN¥399m net cash position means that it deserves a higher P/E than it would if it had a lot of net debt.
The Bottom Line On Beijing Chunlizhengda Medical Instruments's P/E Ratio
Beijing Chunlizhengda Medical Instruments trades on a P/E ratio of 41.3, which is multiples above its market average of 10.2. Its net cash position is the cherry on top of its superb EPS growth. So based on this analysis we'd expect Beijing Chunlizhengda Medical Instruments to have a high P/E ratio. What we know for sure is that investors have become much more excited about Beijing Chunlizhengda Medical Instruments recently, since they have pushed its P/E ratio from 31.6 to 41.3 over the last month. If you like to buy stocks that have recently impressed the market, then this one might be a candidate; but if you prefer to invest when there is 'blood in the streets', then you may feel the opportunity has passed.
When the market is wrong about a stock, it gives savvy investors an opportunity. People often underestimate remarkable growth -- so investors can make money when fast growth is not fully appreciated. So this free report on the analyst consensus forecasts could help you make a master move on this stock.
But note: Beijing Chunlizhengda Medical Instruments 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.