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A Rising Share Price Has Us Looking Closely At G.A. Holdings Limited's (HKG:8126) P/E Ratio

Simply Wall St

G.A. Holdings (HKG:8126) shares have continued recent momentum with a 32% gain in the last month alone. The bad news is that even after that recovery shareholders are still underwater by about 6.3% for the full year.

Assuming no other changes, a sharply higher share price makes a stock less attractive to potential buyers. 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). 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.

Check out our latest analysis for G.A. Holdings

Does G.A. Holdings Have A Relatively High Or Low P/E For Its Industry?

We can tell from its P/E ratio of 10.00 that sentiment around G.A. Holdings isn't particularly high. If you look at the image below, you can see G.A. Holdings has a lower P/E than the average (16.5) in the retail distributors industry classification.

SEHK:8126 Price Estimation Relative to Market, November 5th 2019

This suggests that market participants think G.A. Holdings will underperform other companies in its industry. Since the market seems unimpressed with G.A. Holdings, it's quite possible it could surprise on the upside. You 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. A higher P/E should indicate the stock is expensive relative to others -- and that may encourage shareholders to sell.

G.A. Holdings saw earnings per share decrease by 36% last year. And over the longer term (5 years) earnings per share have decreased 21% annually. This growth rate might warrant a below average P/E ratio.

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

Spending on growth might be good or bad a few years later, but the point is that the P/E ratio does not account for the option (or lack thereof).

So What Does G.A. Holdings's Balance Sheet Tell Us?

G.A. Holdings has net debt worth a very significant 169% of its market capitalization. This level of debt justifies a relatively low P/E, so remain cognizant of the debt, if you're comparing it to other stocks.

The Bottom Line On G.A. Holdings's P/E Ratio

G.A. Holdings has a P/E of 10.0. That's around the same as the average in the HK market, which is 10.4. With relatively high debt, and no earnings per share growth over twelve months, the P/E suggests that many have an expectation that company will find some growth. What is very clear is that the market has become less pessimistic about G.A. Holdings over the last month, with the P/E ratio rising from 7.6 back then to 10.0 today. If you like to buy stocks that could be turnaround opportunities, then this one might be a candidate; but if you're more sensitive to price, 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 G.A. 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).

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.