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How Does Perfect Shape Medical's (HKG:1830) P/E Compare To Its Industry, After Its Big Share Price Gain?

Simply Wall St

Perfect Shape Medical (HKG:1830) shares have had a really impressive month, gaining 35%, after some slippage. Looking back a bit further, we're also happy to report the stock is up 61% in the last year.

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. 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). Investors have optimistic expectations of companies with higher P/E ratios, compared to companies with lower P/E ratios.

Check out our latest analysis for Perfect Shape Medical

Does Perfect Shape Medical Have A Relatively High Or Low P/E For Its Industry?

We can tell from its P/E ratio of 12.35 that sentiment around Perfect Shape Medical isn't particularly high. If you look at the image below, you can see Perfect Shape Medical has a lower P/E than the average (16.6) in the consumer services industry classification.

SEHK:1830 Price Estimation Relative to Market, November 19th 2019

This suggests that market participants think Perfect Shape Medical will underperform other companies in its industry. Since the market seems unimpressed with Perfect Shape Medical, it's quite possible it could surprise on the upside. You should delve deeper. I like to check if company insiders have been buying or selling.

How Growth Rates Impact P/E Ratios

Earnings growth rates have a big influence on P/E ratios. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. And in that case, the P/E ratio itself will drop rather quickly. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.

Perfect Shape Medical's 61% EPS improvement over the last year was like bamboo growth after rain; rapid and impressive. The sweetener is that the annual five year growth rate of 28% is also impressive. With that kind of growth rate we would generally expect a high P/E ratio.

A Limitation: P/E Ratios Ignore Debt and Cash In The Bank

Don't forget that the P/E ratio considers market capitalization. In other words, it does not consider any debt or cash that the company may have on the balance sheet. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.

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.

So What Does Perfect Shape Medical's Balance Sheet Tell Us?

Perfect Shape Medical has net cash of HK$458m. This is fairly high at 12% 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 Perfect Shape Medical's P/E Ratio

Perfect Shape Medical has a P/E of 12.3. That's higher than the average in its market, which is 10.2. Its net cash position is the cherry on top of its superb EPS growth. So based on this analysis we'd expect Perfect Shape Medical to have a high P/E ratio. What we know for sure is that investors have become more excited about Perfect Shape Medical recently, since they have pushed its P/E ratio from 9.1 to 12.3 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. 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 might want to assess this data-rich visualization of earnings, revenue and cash flow.

Of course you might be able to find a better stock than Perfect Shape Medical. So you may wish to see this free collection of other companies that have grown earnings strongly.

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.

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. Thank you for reading.