Shandong Xinhua Pharmaceutical (HKG:719) shares have continued recent momentum with a 37% gain in the last month alone. The full year gain of 31% is pretty reasonable, too.
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. 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.
How Does Shandong Xinhua Pharmaceutical's P/E Ratio Compare To Its Peers?
Shandong Xinhua Pharmaceutical's P/E of 9.61 indicates relatively low sentiment towards the stock. If you look at the image below, you can see Shandong Xinhua Pharmaceutical has a lower P/E than the average (11.9) in the pharmaceuticals industry classification.
Its relatively low P/E ratio indicates that Shandong Xinhua Pharmaceutical shareholders think it will struggle to do as well as other companies in its industry classification. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. 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. Earnings growth means that in the future the 'E' will be higher. And in that case, the P/E ratio itself will drop rather quickly. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.
It's great to see that Shandong Xinhua Pharmaceutical grew EPS by 20% in the last year. And its annual EPS growth rate over 5 years is 41%. So one might expect an above average P/E ratio.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
The 'Price' in P/E reflects the market capitalization of the company. 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.
How Does Shandong Xinhua Pharmaceutical's Debt Impact Its P/E Ratio?
Net debt totals 17% of Shandong Xinhua Pharmaceutical's market cap. This could bring some additional risk, and reduce the number of investment options for management; worth remembering if you compare its P/E to businesses without debt.
The Bottom Line On Shandong Xinhua Pharmaceutical's P/E Ratio
Shandong Xinhua Pharmaceutical has a P/E of 9.6. That's around the same as the average in the HK market, which is 10.3. With only modest debt levels, and strong earnings growth, the market seems to doubt that the growth can be maintained. What is very clear is that the market has become less pessimistic about Shandong Xinhua Pharmaceutical over the last month, with the P/E ratio rising from 7.0 back then to 9.6 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.
Investors have an opportunity when market expectations about a stock are wrong. If the reality for a company is not as bad as the P/E ratio indicates, then the share price should increase as the market realizes this. Although we don't have analyst forecasts shareholders might want to examine this detailed historical graph of earnings, revenue and cash flow.
But note: Shandong Xinhua Pharmaceutical 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 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.
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