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A Rising Share Price Has Us Looking Closely At Homeland Interactive Technology Ltd.'s (HKG:3798) P/E Ratio

Simply Wall St

It's really great to see that even after a strong run, Homeland Interactive Technology (HKG:3798) shares have been powering on, with a gain of 38% in the last thirty days. While recent buyers might be laughing, long term holders might not be so pleased, since the recent gain only brings the full year return to evens.

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). 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.

Check out our latest analysis for Homeland Interactive Technology

Does Homeland Interactive Technology Have A Relatively High Or Low P/E For Its Industry?

We can tell from its P/E ratio of 11.88 that sentiment around Homeland Interactive Technology isn't particularly high. The image below shows that Homeland Interactive Technology has a lower P/E than the average (13.0) P/E for companies in the entertainment industry.

SEHK:3798 Price Estimation Relative to Market, February 8th 2020

Its relatively low P/E ratio indicates that Homeland Interactive Technology shareholders think it will struggle to do as well as other companies in its industry classification. Since the market seems unimpressed with Homeland Interactive Technology, it's quite possible it could surprise on the upside. 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. That's because companies that grow earnings per share quickly will rapidly increase the 'E' in the equation. That means even if the current P/E is high, it will reduce over time if the share price stays flat. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.

Most would be impressed by Homeland Interactive Technology earnings growth of 20% in the last year. And its annual EPS growth rate over 5 years is 51%. With that performance, you might expect an above average P/E ratio.

Remember: P/E Ratios Don't Consider The Balance Sheet

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. Theoretically, a business can improve its earnings (and produce a lower P/E in the future) by investing in growth. That means taking on debt (or spending its cash).

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).

How Does Homeland Interactive Technology's Debt Impact Its P/E Ratio?

Since Homeland Interactive Technology holds net cash of CN¥340m, it can spend on growth, justifying a higher P/E ratio than otherwise.

The Bottom Line On Homeland Interactive Technology's P/E Ratio

Homeland Interactive Technology trades on a P/E ratio of 11.9, which is above its market average of 9.9. With cash in the bank the company has plenty of growth options -- and it is already on the right track. So it does not seem strange that the P/E is above average. What we know for sure is that investors have become more excited about Homeland Interactive Technology recently, since they have pushed its P/E ratio from 8.6 to 11.9 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. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. Although we don't have analyst forecasts shareholders might want to examine this detailed historical graph of earnings, revenue and cash flow.

Of course you might be able to find a better stock than Homeland Interactive Technology. 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 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.