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It's really great to see that even after a strong run, Cango (NYSE:CANG) shares have been powering on, with a gain of 31% in the last thirty days. The full year gain of 21% is pretty reasonable, too.
All else being equal, a sharp share price increase should make a stock less attractive to potential investors. 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. 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 Cango Have A Relatively High Or Low P/E For Its Industry?
We can tell from its P/E ratio of 28.65 that sentiment around Cango isn't particularly high. We can see in the image below that the average P/E (32.0) for companies in the online retail industry is higher than Cango's P/E.
Its relatively low P/E ratio indicates that Cango shareholders think it will struggle to do as well as other companies in its industry classification. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. You 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. Earnings growth means that in the future the 'E' will be higher. And in that case, the P/E ratio itself will drop rather quickly. And as that P/E ratio drops, the company will look cheap, unless its share price increases.
Cango's earnings made like a rocket, taking off 135% last year. The cherry on top is that the five year growth rate was an impressive 17% per year. With that kind of growth rate we would generally expect a high P/E ratio.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. 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.
Cango's Balance Sheet
Since Cango holds net cash of CN¥236m, it can spend on growth, justifying a higher P/E ratio than otherwise.
The Verdict On Cango's P/E Ratio
Cango's P/E is 28.7 which is above average (18.8) 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 Cango to have a high P/E ratio. What we know for sure is that investors have become much more excited about Cango recently, since they have pushed its P/E ratio from 21.9 to 28.7 over the last month. 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 visual report on analyst forecasts could hold the key to an excellent investment decision.
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.
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.
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