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A Rising Share Price Has Us Looking Closely At Grown Up Group Investment Holdings Limited's (HKG:1842) P/E Ratio

Simply Wall St

Grown Up Group Investment Holdings (HKG:1842) shares have had a really impressive month, gaining 30%, after some slippage. 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). Investors have optimistic expectations of companies with higher P/E ratios, compared to companies with lower P/E ratios.

See our latest analysis for Grown Up Group Investment Holdings

How Does Grown Up Group Investment Holdings's P/E Ratio Compare To Its Peers?

We can tell from its P/E ratio of 21.84 that there is some investor optimism about Grown Up Group Investment Holdings. You can see in the image below that the average P/E (9.1) for companies in the luxury industry is lower than Grown Up Group Investment Holdings's P/E.

SEHK:1842 Price Estimation Relative to Market, November 28th 2019

Its relatively high P/E ratio indicates that Grown Up Group Investment Holdings shareholders think it will perform better than other companies in its industry classification. Clearly the market expects growth, but it isn't guaranteed. So investors should delve deeper. I like to check if company insiders have been buying or 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. So while a stock may look cheap based on past earnings, it could be expensive based on future earnings.

Grown Up Group Investment Holdings shrunk earnings per share by 26% over the last year. And over the longer term (5 years) earnings per share have decreased 3.6% annually. This might lead to muted expectations.

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. Thus, the metric does not reflect cash or debt held by the company. 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.

Is Debt Impacting Grown Up Group Investment Holdings's P/E?

Grown Up Group Investment Holdings has net cash of HK$38m. That should lead to a higher P/E than if it did have debt, because its strong balance sheets gives it more options.

The Verdict On Grown Up Group Investment Holdings's P/E Ratio

Grown Up Group Investment Holdings's P/E is 21.8 which is above average (10.2) in its market. The recent drop in earnings per share might keep 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 much more excited about Grown Up Group Investment Holdings recently, since they have pushed its P/E ratio from 16.8 to 21.8 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. We don't have analyst forecasts, but shareholders might want to examine this detailed historical graph of earnings, revenue and cash flow.

You might be able to find a better buy than Grown Up Group Investment Holdings. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).

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.