Tokyo Chuo Auction Holdings (HKG:1939) shares have had a really impressive month, gaining 33%, after some slippage. But shareholders may not all be feeling jubilant, since the share price is still down 39% in the last year.
All else being equal, a sharp share price increase should make a stock less attractive to potential investors. 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). So some would prefer to hold off buying when there is a lot of optimism towards a stock. 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). Investors have optimistic expectations of companies with higher P/E ratios, compared to companies with lower P/E ratios.
Does Tokyo Chuo Auction Holdings Have A Relatively High Or Low P/E For Its Industry?
Tokyo Chuo Auction Holdings's P/E is 14.83. The image below shows that Tokyo Chuo Auction Holdings has a P/E ratio that is roughly in line with the consumer services industry average (15.2).
Tokyo Chuo Auction Holdings's P/E tells us that market participants think its prospects are roughly in line with its industry. So if Tokyo Chuo Auction Holdings actually outperforms its peers going forward, that should be a positive for the share price. Checking factors such as director buying and selling. could help you form your own view on if that will happen.
How Growth Rates Impact P/E Ratios
P/E ratios primarily reflect market expectations around earnings growth rates. Earnings growth means that in the future the 'E' will be higher. That means even if the current P/E is high, it will reduce over time if the share price stays flat. And as that P/E ratio drops, the company will look cheap, unless its share price increases.
Tokyo Chuo Auction Holdings saw earnings per share decrease by 13% last year.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. In other words, it does not consider any debt or cash that the company may have on the balance sheet. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
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 Tokyo Chuo Auction Holdings's Debt Impact Its P/E Ratio?
With net cash of HK$143m, Tokyo Chuo Auction Holdings has a very strong balance sheet, which may be important for its business. Having said that, at 37% of its market capitalization the cash hoard would contribute towards a higher P/E ratio.
The Bottom Line On Tokyo Chuo Auction Holdings's P/E Ratio
Tokyo Chuo Auction Holdings has a P/E of 14.8. That's higher than the average in its market, which is 10.6. Falling earnings per share is probably keeping traditional value investors away, but the net cash position means the company has time to improve: and the high P/E suggests the market thinks it will. What we know for sure is that investors have become more excited about Tokyo Chuo Auction Holdings recently, since they have pushed its P/E ratio from 11.2 to 14.8 over the last month. For those who prefer to invest with the flow of momentum, that might mean it's time to put the stock on a watchlist, or research it. But the contrarian may see it as a missed opportunity.
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. 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 Tokyo Chuo Auction Holdings. 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 email@example.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.
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