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How Does MECOM Power and Construction's (HKG:1183) P/E Compare To Its Industry, After Its Big Share Price Gain?

Simply Wall St

It's really great to see that even after a strong run, MECOM Power and Construction (HKG:1183) shares have been powering on, with a gain of 31% in the last thirty days. And the full year gain of 12% isn't too shabby, either!

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.

View our latest analysis for MECOM Power and Construction

How Does MECOM Power and Construction's P/E Ratio Compare To Its Peers?

MECOM Power and Construction's P/E of 37.52 indicates some degree of optimism towards the stock. As you can see below, MECOM Power and Construction has a much higher P/E than the average company (9.7) in the construction industry.

SEHK:1183 Price Estimation Relative to Market, January 1st 2020

Its relatively high P/E ratio indicates that MECOM Power and Construction shareholders think it will perform better than other companies in its industry classification. 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

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.

MECOM Power and Construction saw earnings per share decrease by 49% last year. And EPS is down 16% a year, over the last 5 years. This growth rate might warrant a below average P/E ratio.

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. So it won't reflect the advantage of cash, or disadvantage of debt. 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.

While growth expenditure doesn't always pay off, the point is that it is a good option to have; but one that the P/E ratio ignores.

So What Does MECOM Power and Construction's Balance Sheet Tell Us?

With net cash of MO$270m, MECOM Power and Construction has a very strong balance sheet, which may be important for its business. Having said that, at 19% of its market capitalization the cash hoard would contribute towards a higher P/E ratio.

The Verdict On MECOM Power and Construction's P/E Ratio

MECOM Power and Construction's P/E is 37.5 which is way above average (10.5) in its market. The recent drop in earnings per share would make some investors cautious, but the healthy balance sheet means the company retains potential for future growth. If fails to eventuate, the current high P/E could prove to be temporary, as the share price falls. What is very clear is that the market has become significantly more optimistic about MECOM Power and Construction over the last month, with the P/E ratio rising from 28.6 back then to 37.5 today. If you like to buy stocks that have recently impressed the market, then this one might be a candidate; but if you prefer to invest when there is 'blood in the streets', then you may feel the opportunity has passed.

Investors have an opportunity when market expectations about a stock are wrong. People often underestimate remarkable growth -- so investors can make money when fast growth is not fully appreciated. We don't have analyst forecasts, but you might want to assess this data-rich visualization of earnings, revenue and cash flow.

But note: MECOM Power and Construction 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).

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.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.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.