It's great to see Xiwang Special Steel (HKG:1266) shareholders have their patience rewarded with a 35% share price pop in the last month. However, that doesn't change the fact that longer term shareholders might have been mercilessly wrecked by the 54% share price decline throughout the 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. One way to gauge market expectations of a stock is to look at its Price to Earnings Ratio (PE Ratio). A high P/E implies that investors have high expectations of what a company can achieve compared to a company with a low P/E ratio.
How Does Xiwang Special Steel's P/E Ratio Compare To Its Peers?
Xiwang Special Steel's P/E of 2.32 indicates relatively low sentiment towards the stock. We can see in the image below that the average P/E (9.1) for companies in the metals and mining industry is higher than Xiwang Special Steel's P/E.
This suggests that market participants think Xiwang Special Steel will underperform other companies in its industry. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.
How Growth Rates Impact P/E Ratios
P/E ratios primarily reflect market expectations around earnings growth rates. When earnings grow, the 'E' increases, over time. That means even if the current P/E is high, it will reduce over time if the share price stays flat. And as that P/E ratio drops, the company will look cheap, unless its share price increases.
Xiwang Special Steel saw earnings per share decrease by 53% last year. But it has grown its earnings per share by 4.6% per year over the last five years.
Remember: P/E Ratios Don't Consider The Balance Sheet
It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. That means it doesn't take debt or cash into account. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.
Spending on growth might be good or bad a few years later, but the point is that the P/E ratio does not account for the option (or lack thereof).
Xiwang Special Steel's Balance Sheet
Xiwang Special Steel's net debt is considerable, at 292% of its market cap. This is a relatively high level of debt, so the stock probably deserves a relatively low P/E ratio. Keep that in mind when comparing it to other companies.
The Bottom Line On Xiwang Special Steel's P/E Ratio
Xiwang Special Steel's P/E is 2.3 which is below average (9.8) in the HK market. Given meaningful debt, and a lack of recent growth, the market looks to be extrapolating this recent performance; reflecting low expectations for the future. What we know for sure is that investors are becoming less uncomfortable about Xiwang Special Steel's prospects, since they have pushed its P/E ratio from 1.7 to 2.3 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.
When the market is wrong about a stock, it gives savvy investors an opportunity. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. 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.
Of course you might be able to find a better stock than Xiwang Special Steel. So you may wish to see this free collection of other companies that have grown earnings strongly.
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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