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Cango (NYSE:CANG) shares have continued recent momentum with a 34% gain in the last month alone. The bad news is that even after that recovery shareholders are still underwater by about 8.4% for the full year.
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. One way to gauge market expectations of a stock 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 Cango's P/E Ratio Compare To Its Peers?
Cango's P/E of 23.42 indicates relatively low sentiment towards the stock. We can see in the image below that the average P/E (31.0) for companies in the online retail industry is higher than Cango's P/E.
Cango's P/E tells us that market participants think it will not fare as well as its peers in the same industry. Since the market seems unimpressed with Cango, 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
Earnings growth rates have a big influence on P/E ratios. Earnings growth means that in the future the 'E' will be higher. And in that case, the P/E ratio itself will drop rather quickly. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
In the last year, Cango grew EPS like Taylor Swift grew her fan base back in 2010; the 135% gain was both fast and well deserved. The sweetener is that the annual five year growth rate of 17% is also impressive. So I'd be surprised if the P/E ratio was not above average.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
Don't forget that the P/E ratio considers market capitalization. Thus, the metric does not reflect cash or debt held by the company. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
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).
Cango's Balance Sheet
Since Cango holds net cash of CN¥236m, it can spend on growth, justifying a higher P/E ratio than otherwise.
The Verdict On Cango's P/E Ratio
Cango trades on a P/E ratio of 23.4, which is above its market average of 18.4. The excess cash it carries is the gravy on top its fast EPS growth. To us, this is the sort of company that we would expect to carry an above average price tag (relative to earnings). What we know for sure is that investors have become much more excited about Cango recently, since they have pushed its P/E ratio from 17.5 to 23.4 over the last month. For those who prefer to invest with the flow of momentum, that might mean it's time to put the stock on a watchlist, or research it. But the contrarian may see it as a missed opportunity.
Investors have an opportunity when market expectations about a stock are wrong. 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. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.
Of course you might be able to find a better stock than Cango. So you may wish to see this free collection of other companies that have grown earnings strongly.
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.
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