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A Rising Share Price Has Us Looking Closely At Theme International Holdings Limited's (HKG:990) P/E Ratio

Simply Wall St

Theme International Holdings (HKG:990) shareholders are no doubt pleased to see that the share price has had a great month, posting a 31% gain, recovering from prior weakness. Unfortunately, the full year gain of 2.8% wasn't so sweet.

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). Investors have optimistic expectations of companies with higher P/E ratios, compared to companies with lower P/E ratios.

Check out our latest analysis for Theme International Holdings

How Does Theme International Holdings's P/E Ratio Compare To Its Peers?

Theme International Holdings's P/E of 10.52 indicates some degree of optimism towards the stock. The image below shows that Theme International Holdings has a higher P/E than the average (9.7) P/E for companies in the trade distributors industry.

SEHK:990 Price Estimation Relative to Market, November 6th 2019

Theme 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 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

Generally speaking the rate of earnings growth has a profound impact on a company's P/E multiple. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. 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.

Theme International Holdings's 236% EPS improvement over the last year was like bamboo growth after rain; rapid and impressive.

Remember: P/E Ratios Don't Consider The Balance Sheet

The 'Price' in P/E reflects the market capitalization of the company. In other words, it does not consider any debt or cash that the company may have on the balance sheet. 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.

How Does Theme International Holdings's Debt Impact Its P/E Ratio?

With net cash of HK$669m, Theme International Holdings has a very strong balance sheet, which may be important for its business. Having said that, at 40% of its market capitalization the cash hoard would contribute towards a higher P/E ratio.

The Bottom Line On Theme International Holdings's P/E Ratio

Theme International Holdings trades on a P/E ratio of 10.5, which is fairly close to the HK market average of 10.4. The excess cash it carries is the gravy on top its fast EPS growth. So at a glance we're a bit surprised that Theme International Holdings does not have a higher P/E ratio. What we know for sure is that investors have become more excited about Theme International Holdings recently, since they have pushed its P/E ratio from 8.1 to 10.5 over the last month. 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.

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 shareholders might want to examine this detailed historical graph 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.

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.

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. Thank you for reading.