To the annoyance of some shareholders, Ever-Glory International Group (NASDAQ:EVK) shares are down a considerable in the last month. And that drop will have no doubt have some shareholders concerned that the 60% share price decline, over the last year, has turned them into bagholders. What is a bagholder? It is a shareholder who has suffered a bad loss, but continues to hold indefinitely, without questioning their reasons for holding, even as the losses grow greater.
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. 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). 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.
Does Ever-Glory International Group Have A Relatively High Or Low P/E For Its Industry?
Ever-Glory International Group's P/E of 4.39 indicates relatively low sentiment towards the stock. We can see in the image below that the average P/E (19.0) for companies in the luxury industry is higher than Ever-Glory International Group's P/E.
Ever-Glory International Group's P/E tells us that market participants think it will not fare as well as its peers in the same industry. Since the market seems unimpressed with Ever-Glory International Group, it's quite possible it could surprise on the upside. 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
Companies that shrink earnings per share quickly will rapidly decrease the 'E' in the equation. Therefore, even if you pay a low multiple of earnings now, that multiple will become higher in the future. Then, a higher P/E might scare off shareholders, pushing the share price down.
Ever-Glory International Group's earnings per share fell by 57% in the last twelve months. And EPS is down 18% a year, over the last 5 years. This growth rate might warrant a below average P/E ratio.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. 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.
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).
So What Does Ever-Glory International Group's Balance Sheet Tell Us?
With net cash of US$10m, Ever-Glory International Group has a very strong balance sheet, which may be important for its business. Having said that, at 44% of its market capitalization the cash hoard would contribute towards a higher P/E ratio.
The Bottom Line On Ever-Glory International Group's P/E Ratio
Ever-Glory International Group has a P/E of 4.4. That's below the average in the US market, which is 18.8. The recent drop in earnings per share would make investors cautious, the healthy balance sheet means the company retains potential for future growth. If that occurs, the current low P/E could prove to be temporary. What can be absolutely certain is that the market has become more pessimistic about Ever-Glory International Group over the last month, with the P/E ratio falling from 4.4 back then to 4.4 today. For those who prefer invest in growth, this stock apparently offers limited promise, but the deep value investors may find the pessimism around this stock enticing.
When the market is wrong about a stock, it gives savvy investors an opportunity. 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 you might want to assess this data-rich visualization of earnings, revenue and cash flow.
Of course you might be able to find a better stock than Ever-Glory International Group. 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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