China Sanjiang Fine Chemicals (HKG:2198) shareholders are no doubt pleased to see that the share price has bounced 31% in the last month alone, although it is still down 5.3% over the last quarter. But that gain wasn't enough to make shareholders whole, as the share price is still down 9.6% in the last 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. 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 China Sanjiang Fine Chemicals Have A Relatively High Or Low P/E For Its Industry?
China Sanjiang Fine Chemicals's P/E of 7.97 indicates some degree of optimism towards the stock. The image below shows that China Sanjiang Fine Chemicals has a higher P/E than the average (6.9) P/E for companies in the chemicals industry.
China Sanjiang Fine Chemicals's P/E tells us that market participants think the company will perform better than its industry peers, going forward. Shareholders are clearly optimistic, but the future is always uncertain. So investors should delve deeper. I like to check if company insiders have been buying or selling.
How Growth Rates Impact P/E Ratios
P/E ratios primarily reflect market expectations around earnings growth rates. When earnings grow, the 'E' increases, over time. And in that case, the P/E ratio itself will drop rather quickly. Then, a lower P/E should attract more buyers, pushing the share price up.
China Sanjiang Fine Chemicals's earnings per share fell by 75% in the last twelve months. And over the longer term (5 years) earnings per share have decreased 14% annually. This growth rate might warrant a below average P/E ratio.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
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. 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).
Such expenditure might be good or bad, in the long term, but the point here is that the balance sheet is not reflected by this ratio.
So What Does China Sanjiang Fine Chemicals's Balance Sheet Tell Us?
China Sanjiang Fine Chemicals has net debt worth a very significant 136% of its market capitalization. This level of debt justifies a relatively low P/E, so remain cognizant of the debt, if you're comparing it to other stocks.
The Verdict On China Sanjiang Fine Chemicals's P/E Ratio
China Sanjiang Fine Chemicals has a P/E of 8.0. That's below the average in the HK market, which is 10.3. When you consider that the company has significant debt, and didn't grow EPS last year, it isn't surprising that the market has muted expectations. What is very clear is that the market has become less pessimistic about China Sanjiang Fine Chemicals over the last month, with the P/E ratio rising from 6.1 back then to 8.0 today. If you like to buy stocks that could be turnaround opportunities, then this one might be a candidate; but if you're more sensitive to price, then you may feel the opportunity has passed.
When the market is wrong about a stock, it gives savvy investors an opportunity. 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 you could get a better understanding of its growth by checking out this more detailed historical graph of earnings, revenue and cash flow.
Of course you might be able to find a better stock than China Sanjiang Fine Chemicals. So you may wish to see this free collection of other companies that have grown earnings strongly.
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If you spot an error that warrants correction, please contact the editor at email@example.com. 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.