The G.A. Holdings (HKG:8126) share price has done well in the last month, posting a gain of 33%. 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). 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). 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 G.A. Holdings's P/E Ratio Compare To Its Peers?
We can tell from its P/E ratio of 8.55 that sentiment around G.A. Holdings isn't particularly high. If you look at the image below, you can see G.A. Holdings has a lower P/E than the average (12.7) in the retail distributors industry classification.
This suggests that market participants think G.A. Holdings will underperform other companies in its industry. Many investors like to buy stocks when the market is pessimistic about their prospects. You should delve deeper. I like to check if company insiders have been buying or selling.
How Growth Rates Impact P/E Ratios
When earnings fall, the 'E' decreases, over time. Therefore, even if you pay a low multiple of earnings now, that multiple will become higher in the future. A higher P/E should indicate the stock is expensive relative to others -- and that may encourage shareholders to sell.
G.A. Holdings shrunk earnings per share by 36% over the last year. And EPS is down 21% a year, over the last 5 years. This growth rate might warrant a below average P/E ratio.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. 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 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.
How Does G.A. Holdings's Debt Impact Its P/E Ratio?
G.A. Holdings has net debt worth a very significant 199% 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 Bottom Line On G.A. Holdings's P/E Ratio
G.A. Holdings trades on a P/E ratio of 8.6, which is below the HK market average of 10.5. 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 G.A. Holdings over the last month, with the P/E ratio rising from 6.4 back then to 8.6 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. 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. 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 G.A. Holdings. 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.