In Construction Holdings (HKG:1500) shares have had a really impressive month, gaining 31%, after some slippage. But shareholders may not all be feeling jubilant, since the share price is still down 25% in the last year.
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). 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 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.
Does In Construction Holdings Have A Relatively High Or Low P/E For Its Industry?
We can tell from its P/E ratio of 15.55 that there is some investor optimism about In Construction Holdings. As you can see below, In Construction Holdings has a higher P/E than the average company (10.2) in the construction industry.
In Construction Holdings'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
Companies that shrink earnings per share quickly will rapidly decrease the 'E' in the equation. That means unless the share price falls, the P/E will increase in a few years. A higher P/E should indicate the stock is expensive relative to others -- and that may encourage shareholders to sell.
In Construction Holdings saw earnings per share decrease by 54% last year. And over the longer term (5 years) earnings per share have decreased 33% annually. This might lead to muted expectations.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
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.
In Construction Holdings's Balance Sheet
In Construction Holdings has net cash of HK$65m. This is fairly high at 39% of its market capitalization. That might mean balance sheet strength is important to the business, but should also help push the P/E a bit higher than it would otherwise be.
The Bottom Line On In Construction Holdings's P/E Ratio
In Construction Holdings has a P/E of 15.6. That's higher than the average in its market, which is 10.4. The recent drop in earnings per share might keep value investors away, but the net cash position means the company has time to improve: and the high P/E suggests the market thinks it will. What we know for sure is that investors have become more excited about In Construction Holdings recently, since they have pushed its P/E ratio from 11.9 to 15.6 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.
When the market is wrong about a stock, it gives savvy investors an opportunity. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. We don't have analyst forecasts, but shareholders might want to examine this detailed historical graph of earnings, revenue and cash flow.
Of course you might be able to find a better stock than In Construction Holdings. So you may wish to see this free collection of other companies that have grown earnings strongly.
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