Frontage Holdings (HKG:1521) shares have continued recent momentum with a 31% gain in the last month alone. While recent buyers might be laughing, long term holders might not be so pleased, since the recent gain only brings the full year return to evens.
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). 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.
How Does Frontage Holdings's P/E Ratio Compare To Its Peers?
Frontage Holdings's P/E is 51.37. As you can see below Frontage Holdings has a P/E ratio that is fairly close for the average for the life sciences industry, which is 49.9.
Its P/E ratio suggests that Frontage Holdings shareholders think that in the future it will perform about the same as other companies in its industry classification. If the company has better than average prospects, then the market might be underestimating it. I would further inform my view by checking insider buying and selling., among other things.
How Growth Rates Impact P/E Ratios
Generally speaking the rate of earnings growth has a profound impact on a company's P/E multiple. Earnings growth means that in the future the 'E' will be higher. That means unless the share price increases, the P/E will reduce in a few years. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
Frontage Holdings's earnings made like a rocket, taking off 61% last year. The cherry on top is that the five year growth rate was an impressive 19% per year. With that kind of growth rate we would generally expect a high P/E ratio.
Remember: P/E Ratios Don't Consider The Balance Sheet
The 'Price' in P/E reflects the market capitalization of the company. Thus, the metric does not reflect cash or debt held by the company. 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.
Such spending might be good or bad, overall, but the key point here is that you need to look at debt to understand the P/E ratio in context.
Is Debt Impacting Frontage Holdings's P/E?
With net cash of US$210m, Frontage Holdings has a very strong balance sheet, which may be important for its business. Having said that, at 20% of its market capitalization the cash hoard would contribute towards a higher P/E ratio.
The Verdict On Frontage Holdings's P/E Ratio
With a P/E ratio of 51.4, Frontage Holdings is expected to grow earnings very strongly in the years to come. The excess cash it carries is the gravy on top its fast EPS growth. So based on this analysis we'd expect Frontage Holdings to have a high P/E ratio. What is very clear is that the market has become significantly more optimistic about Frontage Holdings over the last month, with the P/E ratio rising from 39.1 back then to 51.4 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. 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 visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.
But note: Frontage 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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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. Thank you for reading.