Huan Yue Interactive Holdings (HKG:505) shares have had a really impressive month, gaining 33%, after some slippage. Longer term shareholders are no doubt thankful for the recovery in the share price, since it's pretty much flat for the year, even after the recent pop.
All else being equal, a sharp share price increase should make a stock less attractive to potential investors. While the market sentiment towards a stock is very changeable, in the long run, the share price will tend to move in the same direction as earnings per share. The implication here is that deep value investors might steer clear when expectations of a company are too high. 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 implies that investors have high expectations of what a company can achieve compared to a company with a low P/E ratio.
Does Huan Yue Interactive Holdings Have A Relatively High Or Low P/E For Its Industry?
We can tell from its P/E ratio of 14.00 that there is some investor optimism about Huan Yue Interactive Holdings. The image below shows that Huan Yue Interactive Holdings has a higher P/E than the average (9.7) P/E for companies in the electrical industry.
That means that the market expects Huan Yue Interactive Holdings will outperform other companies in its industry. The market is optimistic about the future, but that doesn't guarantee future growth. 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
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. So while a stock may look cheap based on past earnings, it could be expensive based on future earnings.
Huan Yue Interactive Holdings's earnings per share fell by 69% in the last twelve months. And over the longer term (3 years) earnings per share have decreased 8.3% annually. This could justify a low P/E.
Remember: P/E Ratios Don't Consider The Balance Sheet
It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. That means it doesn't take debt or cash into account. 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.
Huan Yue Interactive Holdings's Balance Sheet
Net debt totals a substantial 130% of Huan Yue Interactive Holdings's market cap. If you want to compare its P/E ratio to other companies, you must keep in mind that these debt levels would usually warrant a relatively low P/E.
The Bottom Line On Huan Yue Interactive Holdings's P/E Ratio
Huan Yue Interactive Holdings's P/E is 14.0 which is above average (10.5) in its market. With meaningful debt and a lack of recent earnings growth, the market has high expectations that the business will earn more in the future. What is very clear is that the market has become more optimistic about Huan Yue Interactive Holdings over the last month, with the P/E ratio rising from 10.6 back then to 14.0 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. Although we don't have analyst forecasts you could get a better understanding of its growth by checking out this more detailed historical graph of earnings, revenue and cash flow.
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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