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It's really great to see that even after a strong run, China MeiDong Auto Holdings (HKG:1268) shares have been powering on, with a gain of 30% in the last thirty days. Zooming out, the annual gain of 280% knocks our socks off.
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. 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 China MeiDong Auto Holdings Have A Relatively High Or Low P/E For Its Industry?
We can tell from its P/E ratio of 31.89 that there is some investor optimism about China MeiDong Auto Holdings. The image below shows that China MeiDong Auto Holdings has a significantly higher P/E than the average (9.9) P/E for companies in the specialty retail industry.
Its relatively high P/E ratio indicates that China MeiDong Auto Holdings 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
Probably the most important factor in determining what P/E a company trades on is the earnings growth. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.
China MeiDong Auto Holdings's earnings made like a rocket, taking off 51% last year. The sweetener is that the annual five year growth rate of 34% is also impressive. So I'd be surprised if the P/E ratio was not above average.
Remember: P/E Ratios Don't Consider The Balance Sheet
The 'Price' in P/E reflects the market capitalization of the company. So it won't reflect the advantage of cash, or disadvantage of debt. 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.
While growth expenditure doesn't always pay off, the point is that it is a good option to have; but one that the P/E ratio ignores.
China MeiDong Auto Holdings's Balance Sheet
Since China MeiDong Auto Holdings holds net cash of CN¥6.6m, it can spend on growth, justifying a higher P/E ratio than otherwise.
The Verdict On China MeiDong Auto Holdings's P/E Ratio
China MeiDong Auto Holdings's P/E is 31.9 which is way above average (9.7) in its market. The excess cash it carries is the gravy on top its fast EPS growth. So based on this analysis we'd expect China MeiDong Auto Holdings to have a high P/E ratio. What is very clear is that the market has become significantly more optimistic about China MeiDong Auto Holdings over the last month, with the P/E ratio rising from 24.5 back then to 31.9 today. 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 should be looking to buy stocks that the market is wrong about. People often underestimate remarkable growth -- so investors can make money when fast growth is not fully appreciated. So this free visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.
But note: China MeiDong Auto Holdings 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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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. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned. Thank you for reading.