mm2 Asia (SGX:1B0) shares have had a really impressive month, gaining 32%, after some slippage. But shareholders may not all be feeling jubilant, since the share price is still down 29% in the last year.
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. 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). 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 mm2 Asia's P/E Ratio Compare To Its Peers?
mm2 Asia's P/E of 14.50 indicates relatively low sentiment towards the stock. We can see in the image below that the average P/E (22.1) for companies in the entertainment industry is higher than mm2 Asia's P/E.
mm2 Asia's P/E tells us that market participants think it will not fare as well as its peers in the same industry. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and selling.
How Growth Rates Impact P/E Ratios
Probably the most important factor in determining what P/E a company trades on is the earnings growth. That's because companies that grow earnings per share quickly will rapidly increase the 'E' in the equation. And in that case, the P/E ratio itself will drop rather quickly. And as that P/E ratio drops, the company will look cheap, unless its share price increases.
mm2 Asia saw earnings per share decrease by 19% last year. But over the longer term (3 years), earnings per share have increased by 8.2%. And over the longer term (5 years) earnings per share have decreased 75% annually. This could justify a pessimistic P/E.
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. That means it doesn't take debt or cash into account. 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.
How Does mm2 Asia's Debt Impact Its P/E Ratio?
mm2 Asia has net debt worth 85% of its market capitalization. This is enough debt that you'd have to make some adjustments before using the P/E ratio to compare it to a company with net cash.
The Verdict On mm2 Asia's P/E Ratio
mm2 Asia trades on a P/E ratio of 14.5, which is above its market average of 13.1. With relatively high debt, and no earnings per share growth over twelve months, it's safe to say the market believes the company will improve its earnings growth in the future. What we know for sure is that investors have become more excited about mm2 Asia recently, since they have pushed its P/E ratio from 11.0 to 14.5 over the last month. If you like to buy stocks that have recently impressed the market, then this one might be a candidate; but if you prefer to invest when there is 'blood in the streets', then you may feel the opportunity has passed.
Investors should be looking to buy stocks that the market is wrong about. People often underestimate remarkable growth -- so investors can make money when fast growth is not fully appreciated. So this free report on the analyst consensus forecasts could help you make a master move on this stock.
But note: mm2 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).
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