China Distance Education Holdings (NYSE:DL) shareholders are no doubt pleased to see that the share price has had a great month, posting a 31% gain, recovering from prior weakness. But shareholders may not all be feeling jubilant, since the share price is still down 26% in the last year.
Assuming no other changes, a sharply higher share price makes a stock less 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 some would prefer to hold off buying when there is a lot of optimism towards a stock. One way to gauge market expectations of a stock 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.
Does China Distance Education Holdings Have A Relatively High Or Low P/E For Its Industry?
China Distance Education Holdings's P/E of 11.19 indicates relatively low sentiment towards the stock. We can see in the image below that the average P/E (27.5) for companies in the consumer services industry is higher than China Distance Education Holdings's P/E.
Its relatively low P/E ratio indicates that China Distance Education Holdings shareholders think it will struggle to do as well as other companies in its industry classification. 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
When earnings fall, the 'E' decreases, over time. That means unless the share price falls, the P/E will increase in a few years. A higher P/E should indicate the stock is expensive relative to others -- and that may encourage shareholders to sell.
In the last year, China Distance Education Holdings grew EPS like Taylor Swift grew her fan base back in 2010; the 118% gain was both fast and well deserved. Regrettably, the longer term performance is poor, with EPS down 1.5% per year over 5 years.
Remember: P/E Ratios Don't Consider The Balance Sheet
Don't forget that the P/E ratio considers market capitalization. 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.
So What Does China Distance Education Holdings's Balance Sheet Tell Us?
China Distance Education Holdings has net cash of US$41m. This is fairly high at 21% of its market capitalization. That might mean balance sheet strength is important to the business, but should also help push the P/E a bit higher than it would otherwise be.
The Verdict On China Distance Education Holdings's P/E Ratio
China Distance Education Holdings trades on a P/E ratio of 11.2, which is below the US market average of 17.4. The net cash position gives plenty of options to the business, and the recent improvement in EPS is good to see. The relatively low P/E ratio implies the market is pessimistic. Since analysts are predicting growth will continue, one might expect to see a higher P/E so it may be worth looking closer What is very clear is that the market has become more optimistic about China Distance Education Holdings over the last month, with the P/E ratio rising from 8.5 back then to 11.2 today. 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 have an opportunity when market expectations about a stock are wrong. 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. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.
Of course you might be able to find a better stock than China Distance Education Holdings. So you may wish to see this free collection of other companies that have grown earnings strongly.
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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. Thank you for reading.