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How Does Zhong Ao Home Group's (HKG:1538) P/E Compare To Its Industry, After Its Big Share Price Gain?

Zhong Ao Home Group (HKG:1538) shareholders are no doubt pleased to see that the share price has had a great month, posting a 31% gain, recovering from prior weakness. The bad news is that even after that recovery shareholders are still underwater by about 6.5% for the full year.

Assuming no other changes, a sharply higher share price makes a stock less attractive to potential buyers. 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. 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.

View our latest analysis for Zhong Ao Home Group

How Does Zhong Ao Home Group's P/E Ratio Compare To Its Peers?

We can tell from its P/E ratio of 5.22 that sentiment around Zhong Ao Home Group isn't particularly high. If you look at the image below, you can see Zhong Ao Home Group has a lower P/E than the average (6.8) in the real estate industry classification.

SEHK:1538 Price Estimation Relative to Market, February 20th 2020
SEHK:1538 Price Estimation Relative to Market, February 20th 2020

This suggests that market participants think Zhong Ao Home Group will underperform other companies in its industry. Many investors like to buy stocks when the market is pessimistic about their prospects. You should delve deeper. I like to check if company insiders have been buying or selling.

How Growth Rates Impact P/E Ratios

P/E ratios primarily reflect market expectations around earnings growth rates. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. That means even if the current P/E is high, it will reduce over time if the share price stays flat. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.

Zhong Ao Home Group's earnings per share grew by -8.7% in the last twelve months. And it has bolstered its earnings per share by 11% per year over the last five years.

A Limitation: P/E Ratios Ignore Debt and Cash In The Bank

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. The exact same company would hypothetically deserve a higher P/E ratio if it had a strong balance sheet, than if it had a weak one with lots of debt, because a cashed up company can spend on growth.

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.

Zhong Ao Home Group's Balance Sheet

With net cash of CN¥251m, Zhong Ao Home Group has a very strong balance sheet, which may be important for its business. Having said that, at 45% of its market capitalization the cash hoard would contribute towards a higher P/E ratio.

The Bottom Line On Zhong Ao Home Group's P/E Ratio

Zhong Ao Home Group's P/E is 5.2 which is below average (10.2) in the HK market. Earnings improved over the last year. Also positive, the relatively strong balance sheet will allow for investment in growth. In contrast, the P/E indicates shareholders doubt that will happen! What we know for sure is that investors are becoming less uncomfortable about Zhong Ao Home Group's prospects, since they have pushed its P/E ratio from 4.0 to 5.2 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 shareholders might want to examine this detailed historical graph of earnings, revenue and cash flow.

But note: Zhong Ao Home Group 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 editorial-team@simplywallst.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.

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.

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