The Tianli Education International Holdings (HKG:1773) share price has done well in the last month, posting a gain of 31%. That's tops off a massive gain of 145% 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). 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 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.
How Does Tianli Education International Holdings's P/E Ratio Compare To Its Peers?
We can tell from its P/E ratio of 30.86 that there is some investor optimism about Tianli Education International Holdings. You can see in the image below that the average P/E (16.3) for companies in the consumer services industry is lower than Tianli Education International Holdings's P/E.
Tianli Education International Holdings's P/E tells us that market participants think the company will perform better than its industry peers, going forward. Shareholders are clearly optimistic, but the future is always uncertain. So investors should delve deeper. I like to check if company insiders have been buying or 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. When earnings grow, the 'E' increases, over time. 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.
Tianli Education International Holdings increased earnings per share by 8.4% last year.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. So it won't reflect the advantage of cash, or disadvantage of debt. 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).
Such expenditure might be good or bad, in the long term, but the point here is that the balance sheet is not reflected by this ratio.
So What Does Tianli Education International Holdings's Balance Sheet Tell Us?
Since Tianli Education International Holdings holds net cash of CN¥626m, it can spend on growth, justifying a higher P/E ratio than otherwise.
The Verdict On Tianli Education International Holdings's P/E Ratio
Tianli Education International Holdings trades on a P/E ratio of 30.9, which is above its market average of 10.6. Earnings improved over the last year. Also positive, the relatively strong balance sheet will allow for investment in growth -- and the P/E indicates shareholders that will happen! What is very clear is that the market has become significantly more optimistic about Tianli Education International Holdings over the last month, with the P/E ratio rising from 23.6 back then to 30.9 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 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 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 Tianli Education International 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 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.
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