Wing Fung Group Asia (HKG:8526) shareholders are no doubt pleased to see that the share price has had a great month, posting a 42% gain, recovering from prior weakness. But shareholders may not all be feeling jubilant, since the share price is still down 26% 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). The implication here is that deep value investors might steer clear when expectations of a company are too high. One way to gauge market expectations of a stock is to look at its Price to Earnings Ratio (PE Ratio). A high P/E ratio means that investors have a high expectation about future growth, while a low P/E ratio means they have low expectations about future growth.
How Does Wing Fung Group Asia's P/E Ratio Compare To Its Peers?
Wing Fung Group Asia's P/E of 19.36 indicates some degree of optimism towards the stock. You can see in the image below that the average P/E (10.4) for companies in the construction industry is lower than Wing Fung Group Asia's P/E.
That means that the market expects Wing Fung Group Asia 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
If earnings fall then in the future the 'E' will be lower. Therefore, even if you pay a low multiple of earnings now, that multiple will become higher in the future. A higher P/E should indicate the stock is expensive relative to others -- and that may encourage shareholders to sell.
Wing Fung Group Asia's 112% EPS improvement over the last year was like bamboo growth after rain; rapid and impressive. Regrettably, the longer term performance is poor, with EPS down 12% per year over 5 years.
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.
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 Wing Fung Group Asia's Balance Sheet Tell Us?
Wing Fung Group Asia has net cash of HK$22m. That should lead to a higher P/E than if it did have debt, because its strong balance sheets gives it more options.
The Bottom Line On Wing Fung Group Asia's P/E Ratio
Wing Fung Group Asia has a P/E of 19.4. That's higher than the average in its market, which is 10.5. Its net cash position is the cherry on top of its superb EPS growth. So based on this analysis we'd expect Wing Fung Group Asia to have a high P/E ratio. What is very clear is that the market has become significantly more optimistic about Wing Fung Group Asia over the last month, with the P/E ratio rising from 13.6 back then to 19.4 today. 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.
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. We don't have analyst forecasts, but you might want to assess this data-rich visualization of earnings, revenue and cash flow.
But note: Wing Fung Group Asia 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).
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 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. Thank you for reading.