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How Does AK Medical Holdings's (HKG:1789) P/E Compare To Its Industry, After Its Big Share Price Gain?

Simply Wall St

It's really great to see that even after a strong run, AK Medical Holdings (HKG:1789) shares have been powering on, with a gain of 36% in the last thirty days. Looking back a bit further, we're also happy to report the stock is up 91% 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). 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). A high P/E implies that investors have high expectations of what a company can achieve compared to a company with a low P/E ratio.

Check out our latest analysis for AK Medical Holdings

Does AK Medical Holdings Have A Relatively High Or Low P/E For Its Industry?

AK Medical Holdings's P/E of 45.56 indicates some degree of optimism towards the stock. You can see in the image below that the average P/E (16.4) for companies in the medical equipment industry is lower than AK Medical Holdings's P/E.

SEHK:1789 Price Estimation Relative to Market, November 7th 2019

AK Medical Holdings's P/E tells us that market participants think the company will perform better than its industry peers, going forward. Clearly the market expects growth, but it isn't guaranteed. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.

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. That means unless the share price increases, the P/E will reduce in a few years. And as that P/E ratio drops, the company will look cheap, unless its share price increases.

It's nice to see that AK Medical Holdings grew EPS by a stonking 39% in the last year. And its annual EPS growth rate over 5 years is 23%. With that performance, I would expect it to have an above average P/E ratio.

A Limitation: P/E Ratios Ignore Debt and Cash In The Bank

One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. 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 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.

Is Debt Impacting AK Medical Holdings's P/E?

AK Medical Holdings has net cash of CN¥516m. That should lead to a higher P/E than if it did have debt, because its strong balance sheets gives it more options.

The Bottom Line On AK Medical Holdings's P/E Ratio

AK Medical Holdings's P/E is 45.6 which is way above average (10.5) in its market. Its net cash position is the cherry on top of its superb EPS growth. So based on this analysis we'd expect AK Medical Holdings to have a high P/E ratio. What we know for sure is that investors have become much more excited about AK Medical Holdings recently, since they have pushed its P/E ratio from 33.4 to 45.6 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.

When the market is wrong about a stock, it gives savvy investors an opportunity. 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 report on the analyst consensus forecasts could help you make a master move on this stock.

Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.

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.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.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.