Art Group Holdings (HKG:565) shareholders are no doubt pleased to see that the share price has had a great month, posting a 33% gain, recovering from prior weakness. The full year gain of 22% is pretty reasonable, too.
All else being equal, a sharp share price increase should make a stock less attractive to potential investors. While the market sentiment towards a stock is very changeable, in the long run, the share price will tend to move in the same direction as earnings per share. 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 Art Group Holdings Have A Relatively High Or Low P/E For Its Industry?
We can tell from its P/E ratio of 14.42 that there is some investor optimism about Art Group Holdings. The image below shows that Art Group Holdings has a higher P/E than the average (7.1) P/E for companies in the real estate industry.
Art Group 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 further research is always essential. I often monitor director buying and selling.
How Growth Rates Impact P/E Ratios
When earnings fall, the 'E' decreases, over time. That means even if the current P/E is low, it will increase over time if the share price stays flat. Then, a higher P/E might scare off shareholders, pushing the share price down.
Art Group Holdings shrunk earnings per share by 17% over the last year. But over the longer term (5 years) earnings per share have increased by 23%. And it has shrunk its earnings per share by 29% per year over the last three years. This could justify a low P/E.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
Don't forget that the P/E ratio considers market capitalization. That means it doesn't take debt or cash into account. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
Such spending might be good or bad, overall, but the key point here is that you need to look at debt to understand the P/E ratio in context.
Is Debt Impacting Art Group Holdings's P/E?
Art Group Holdings's net debt is 91% of its market cap. If you want to compare its P/E ratio to other companies, you should absolutely keep in mind it has significant borrowings.
The Verdict On Art Group Holdings's P/E Ratio
Art Group Holdings has a P/E of 14.4. That's higher than the average in its market, which is 10.7. With relatively high debt, and no earnings per share growth over twelve months, it's safe to say the market believes the company will improve its earnings growth in the future. What we know for sure is that investors have become more excited about Art Group Holdings recently, since they have pushed its P/E ratio from 10.8 to 14.4 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.
Investors should be looking to buy stocks that the market is wrong about. 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.
You might be able to find a better buy than Art Group 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 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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