It's great to see Dynamic Holdings (HKG:29) shareholders have their patience rewarded with a 77% share price pop in the last month. That's tops off a massive gain of 119% in the last year.
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). 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). A high P/E implies that investors have high expectations of what a company can achieve compared to a company with a low P/E ratio.
How Does Dynamic Holdings's P/E Ratio Compare To Its Peers?
We can tell from its P/E ratio of 33.92 that there is some investor optimism about Dynamic Holdings. You can see in the image below that the average P/E (6.1) for companies in the real estate industry is a lot lower than Dynamic Holdings's P/E.
Dynamic Holdings's P/E tells us that market participants think the company will perform better than its industry peers, going forward. Clearly the market expects growth, but it isn't guaranteed. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.
How Growth Rates Impact P/E Ratios
Companies that shrink earnings per share quickly will rapidly decrease the 'E' in the equation. That means even if the current P/E is low, it will increase over time if the share price stays flat. So while a stock may look cheap based on past earnings, it could be expensive based on future earnings.
Dynamic Holdings's earnings per share fell by 33% in the last twelve months. And over the longer term (5 years) earnings per share have decreased 4.8% annually. This might lead to muted expectations.
Remember: P/E Ratios Don't Consider The Balance Sheet
Don't forget that the P/E ratio considers market capitalization. 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).
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 Dynamic Holdings's Balance Sheet Tell Us?
Dynamic Holdings's net debt is 0.4% of its market cap. It would probably trade on a higher P/E ratio if it had a lot of cash, but I doubt it is having a big impact.
The Verdict On Dynamic Holdings's P/E Ratio
Dynamic Holdings trades on a P/E ratio of 33.9, which is multiples above its market average of 10.5. With modest debt but no EPS growth in the last year, it's fair to say the P/E implies some optimism about future earnings, from the market. What we know for sure is that investors have become much more excited about Dynamic Holdings recently, since they have pushed its P/E ratio from 19.2 to 33.9 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. People often underestimate remarkable growth -- so investors can make money when fast growth is not fully appreciated. Although we don't have analyst forecasts you might want to assess this data-rich visualization of earnings, revenue and cash flow.
Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.
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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. Thank you for reading.