Changhong Jiahua Holdings (HKG:8016) shares have continued recent momentum with a 31% gain in the last month alone. However, the annual gain of 9.2% wasn't so impressive.
All else being equal, a sharp share price increase should make a stock less attractive to potential investors. 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. The implication here is that deep value investors might steer clear when expectations of a company are too high. 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). Investors have optimistic expectations of companies with higher P/E ratios, compared to companies with lower P/E ratios.
Does Changhong Jiahua Holdings Have A Relatively High Or Low P/E For Its Industry?
Changhong Jiahua Holdings's P/E of 6.34 indicates relatively low sentiment towards the stock. We can see in the image below that the average P/E (9.2) for companies in the electronic industry is higher than Changhong Jiahua Holdings's P/E.
This suggests that market participants think Changhong Jiahua Holdings will underperform other companies in its industry. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. If you consider the stock interesting, further research is recommended. For example, 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. And in that case, the P/E ratio itself will drop rather quickly. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.
Changhong Jiahua Holdings saw earnings per share improve by -4.2% last year. And its annual EPS growth rate over 5 years is 8.4%.
Remember: P/E Ratios Don't Consider The Balance Sheet
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. Theoretically, a business can improve its earnings (and produce a lower P/E in the future) by investing in growth. That means taking on debt (or spending its cash).
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 Changhong Jiahua Holdings's Debt Impact Its P/E Ratio?
Net debt is 47% of Changhong Jiahua Holdings's market cap. You'd want to be aware of this fact, but it doesn't bother us.
The Verdict On Changhong Jiahua Holdings's P/E Ratio
Changhong Jiahua Holdings has a P/E of 6.3. That's below the average in the HK market, which is 10.1. The company hasn't stretched its balance sheet, and earnings are improving. The P/E ratio implies the market is cautious about longer term prospects. What we know for sure is that investors are becoming less uncomfortable about Changhong Jiahua Holdings's prospects, since they have pushed its P/E ratio from 4.8 to 6.3 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.
Investors should be looking to buy stocks that the market is wrong about. If the reality for a company is not as bad as the P/E ratio indicates, then the share price should increase as the market realizes this. We don't have analyst forecasts, but shareholders might want to examine this detailed historical graph of earnings, revenue and cash flow.
Of course you might be able to find a better stock than Changhong Jiahua Holdings. 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.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.