It's great to see Vicon Holdings (HKG:3878) shareholders have their patience rewarded with a 32% share price pop in the last month. Looking back a bit further, we're also happy to report the stock is up 68% 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. 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.
Does Vicon Holdings Have A Relatively High Or Low P/E For Its Industry?
Vicon Holdings's P/E of 54.76 indicates some degree of optimism towards the stock. You can see in the image below that the average P/E (9.4) for companies in the construction industry is a lot lower than Vicon Holdings's P/E.
That means that the market expects Vicon 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 delve deeper. I like to check if company insiders have been buying or selling.
How Growth Rates Impact P/E Ratios
When earnings fall, the 'E' decreases, over time. That means unless the share price falls, the P/E will increase in a few years. So while a stock may look cheap based on past earnings, it could be expensive based on future earnings.
Vicon Holdings's earnings per share were pretty steady over the last year. And it has shrunk its earnings per share by 10% per year over the last three years. This growth rate might warrant a low P/E ratio. So you wouldn't expect a very high P/E.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. In other words, it does not consider any debt or cash that the company may have on the balance sheet. 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.
How Does Vicon Holdings's Debt Impact Its P/E Ratio?
Net debt totals just 5.9% of Vicon Holdings's market cap. The market might award it a higher P/E ratio if it had net cash, but its unlikely this low level of net borrowing is having a big impact on the P/E multiple.
The Verdict On Vicon Holdings's P/E Ratio
Vicon Holdings's P/E is 54.8 which suggests the market is more focussed on the future opportunity rather than the current level of earnings. Given the debt is only modest, and earnings are already moving in the right direction, it's not surprising that the market expects continued improvement. What we know for sure is that investors have become much more excited about Vicon Holdings recently, since they have pushed its P/E ratio from 41.4 to 54.8 over the last month. 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 should be looking to buy stocks that the market is wrong about. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. Although we don't have analyst forecasts shareholders might want to examine this detailed historical graph of earnings, revenue and cash flow.
But note: Vicon Holdings 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.