Shaanxi Northwest New Technology Industry (HKG:8258) shares have had a really impressive month, gaining 52%, after some slippage. But shareholders may not all be feeling jubilant, since the share price is still down 28% 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. 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.
Does Shaanxi Northwest New Technology Industry Have A Relatively High Or Low P/E For Its Industry?
Shaanxi Northwest New Technology Industry's P/E of 9.99 indicates some degree of optimism towards the stock. You can see in the image below that the average P/E (6.9) for companies in the chemicals industry is lower than Shaanxi Northwest New Technology Industry's P/E.
That means that the market expects Shaanxi Northwest New Technology Industry will outperform other companies in its industry. Shareholders are clearly optimistic, but the future is always uncertain. 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
Generally speaking the rate of earnings growth has a profound impact on a company's P/E multiple. When earnings grow, the 'E' increases, over time. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. Then, a lower P/E should attract more buyers, pushing the share price up.
Shaanxi Northwest New Technology Industry's 76% EPS improvement over the last year was like bamboo growth after rain; rapid and impressive. Even better, EPS is up 70% per year over three years. So we'd absolutely expect it to have a relatively high P/E ratio.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
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. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
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.
So What Does Shaanxi Northwest New Technology Industry's Balance Sheet Tell Us?
Shaanxi Northwest New Technology Industry has net cash of CN¥61m. This is fairly high at 55% 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 Verdict On Shaanxi Northwest New Technology Industry's P/E Ratio
Shaanxi Northwest New Technology Industry has a P/E of 10.0. That's around the same as the average in the HK market, which is 9.8. The excess cash it carries is the gravy on top its fast EPS growth. So based on this analysis we'd expect Shaanxi Northwest New Technology Industry to have a higher P/E ratio. What we know for sure is that investors are becoming less uncomfortable about Shaanxi Northwest New Technology Industry's prospects, since they have pushed its P/E ratio from 6.6 to 10.0 over the last month. For those who like to invest in turnarounds, that might mean it's time to put the stock on a watchlist, or research it. But others might consider the opportunity to have passed.
Investors should be looking to buy stocks that the market is wrong about. 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 could get a better understanding of its growth by checking out this more detailed historical graph of earnings, revenue and cash flow.
But note: Shaanxi Northwest New Technology Industry 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 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.
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.