It's really great to see that even after a strong run, Frontage Holdings (HKG:1521) shares have been powering on, with a gain of 32% 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. One way to gauge market expectations of a stock is to look at its Price to Earnings Ratio (PE Ratio). A high P/E ratio means that investors have a high expectation about future growth, while a low P/E ratio means they have low expectations about future growth.
Does Frontage Holdings Have A Relatively High Or Low P/E For Its Industry?
Frontage Holdings has a P/E ratio of 60.58. As you can see below Frontage Holdings has a P/E ratio that is fairly close for the average for the life sciences industry, which is 58.2.
That indicates that the market expects Frontage Holdings will perform roughly in line with other companies in its industry. So if Frontage Holdings actually outperforms its peers going forward, that should be a positive for the share price. I would further inform my view by checking insider buying and selling., among other things.
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 unless the share price increases, the P/E will reduce in a few years. And as that P/E ratio drops, the company will look cheap, unless its share price increases.
Frontage Holdings's earnings made like a rocket, taking off 61% last year. The sweetener is that the annual five year growth rate of 19% is also impressive. With that kind of growth rate we would generally expect a high P/E ratio.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
Don't forget that the P/E ratio considers market capitalization. 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.
Such spending might be good or bad, overall, but the key point here is that you need to look at debt to understand the P/E ratio in context.
Is Debt Impacting Frontage Holdings's P/E?
With net cash of US$210m, Frontage Holdings has a very strong balance sheet, which may be important for its business. Having said that, at 15% of its market capitalization the cash hoard would contribute towards a higher P/E ratio.
The Verdict On Frontage Holdings's P/E Ratio
With a P/E ratio of 60.6, Frontage Holdings is expected to grow earnings very strongly in the years to come. Its net cash position is the cherry on top of its superb EPS growth. So based on this analysis we'd expect Frontage Holdings to have a high P/E ratio. What is very clear is that the market has become significantly more optimistic about Frontage Holdings over the last month, with the P/E ratio rising from 46.0 back then to 60.6 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. People often underestimate remarkable growth -- so investors can make money when fast growth is not fully appreciated. 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 Frontage Holdings. So you may wish to see this free collection of other companies that have grown earnings strongly.
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