It's really great to see that even after a strong run, China Distance Education Holdings (NYSE:DL) shares have been powering on, with a gain of 30% in the last thirty days. Unfortunately, the full year gain of 2.1% wasn't so sweet.
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. 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 China Distance Education Holdings's P/E Ratio Compare To Its Peers?
China Distance Education Holdings's P/E of 12.25 indicates relatively low sentiment towards the stock. We can see in the image below that the average P/E (28.2) for companies in the consumer services industry is higher than China Distance Education Holdings's P/E.
China Distance Education Holdings's P/E tells us that market participants think it will not fare as well as its peers in the same industry. 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. That means even if the current P/E is low, it will increase over time if the share price stays flat. A higher P/E should indicate the stock is expensive relative to others -- and that may encourage shareholders to sell.
China Distance Education Holdings's earnings made like a rocket, taking off 83% last year. Unfortunately, earnings per share are down 5.9% a year, over 3 years.
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. That means it doesn't take debt or cash into account. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
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.
How Does China Distance Education Holdings's Debt Impact Its P/E Ratio?
With net cash of US$52m, China Distance Education Holdings has a very strong balance sheet, which may be important for its business. Having said that, at 20% of its market capitalization the cash hoard would contribute towards a higher P/E ratio.
The Verdict On China Distance Education Holdings's P/E Ratio
China Distance Education Holdings's P/E is 12.3 which is below average (18.2) in the US market. The net cash position gives plenty of options to the business, and the recent improvement in EPS is good to see. The below average P/E ratio suggests that market participants don't believe the strong growth will continue. Given analysts are expecting further growth, one I would have expected a higher P/E ratio. So this stock may well be worth further research. What we know for sure is that investors have become more excited about China Distance Education Holdings recently, since they have pushed its P/E ratio from 9.4 to 12.3 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.
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 China Distance Education Holdings. So you may wish to see this free collection of other companies that have grown earnings strongly.
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