To the annoyance of some shareholders, Linocraft Holdings (HKG:8383) shares are down a considerable 47% in the last month. And that drop will have no doubt have some shareholders concerned that the 64% share price decline, over the last year, has turned them into bagholders. For those wondering, a bagholder is someone who keeps holding a losing stock indefinitely, without taking the time to consider its prospects carefully, going forward.
Assuming nothing else has changed, a lower share price makes a stock more attractive to potential buyers. 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, on certain occasions, long term focussed investors try to take advantage of pessimistic expectations to buy shares at a better price. 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.
How Does Linocraft Holdings's P/E Ratio Compare To Its Peers?
Linocraft Holdings's P/E of 6.88 indicates relatively low sentiment towards the stock. If you look at the image below, you can see Linocraft Holdings has a lower P/E than the average (12.6) in the commercial services industry classification.
Linocraft Holdings's P/E tells us that market participants think it will not fare as well as its peers in the same 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
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.
Linocraft Holdings shrunk earnings per share by 6.2% last year. And it has shrunk its earnings per share by 16% 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
The 'Price' in P/E reflects the market capitalization of the company. That means it doesn't take debt or cash into account. 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 Linocraft Holdings's Balance Sheet Tell Us?
Linocraft Holdings has net debt worth a very significant 207% of its market capitalization. If you want to compare its P/E ratio to other companies, you must keep in mind that these debt levels would usually warrant a relatively low P/E.
The Bottom Line On Linocraft Holdings's P/E Ratio
Linocraft Holdings trades on a P/E ratio of 6.9, which is below the HK market average of 10.2. The P/E reflects market pessimism that probably arises from the lack of recent EPS growth, paired with significant leverage. What can be absolutely certain is that the market has become more pessimistic about Linocraft Holdings over the last month, with the P/E ratio falling from 12.9 back then to 6.9 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. As value investor Benjamin Graham famously said, 'In the short run, the market is a voting machine but in the long run, it is a weighing machine. We don't have analyst forecasts, but shareholders might want to examine this detailed historical graph of earnings, revenue and cash flow.
You might be able to find a better buy than Linocraft Holdings. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
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.
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