It's really great to see that even after a strong run, Beijing Chunlizhengda Medical Instruments (HKG:1858) shares have been powering on, with a gain of 33% in the last thirty days. That's tops off a massive gain of 289% 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). The implication here is that deep value investors might steer clear when expectations of a company are too high. One way to gauge market expectations of a stock 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 Beijing Chunlizhengda Medical Instruments Have A Relatively High Or Low P/E For Its Industry?
Beijing Chunlizhengda Medical Instruments's P/E of 35.87 indicates some degree of optimism towards the stock. The image below shows that Beijing Chunlizhengda Medical Instruments has a higher P/E than the average (16.2) P/E for companies in the medical equipment industry.
Beijing Chunlizhengda Medical Instruments's P/E tells us that market participants think the company will perform better than its industry peers, going forward. The market is optimistic about the future, but that doesn't guarantee future growth. So further research is always essential. I often monitor director buying and selling.
How Growth Rates Impact P/E Ratios
P/E ratios primarily reflect market expectations around earnings growth rates. 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. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
Beijing Chunlizhengda Medical Instruments's 99% EPS improvement over the last year was like bamboo growth after rain; rapid and impressive. The cherry on top is that the five year growth rate was an impressive 26% per year. With that kind of growth rate we would generally expect a high P/E ratio.
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. 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).
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 Beijing Chunlizhengda Medical Instruments's Balance Sheet Tell Us?
Beijing Chunlizhengda Medical Instruments has net cash of CN¥399m. That should lead to a higher P/E than if it did have debt, because its strong balance sheets gives it more options.
The Bottom Line On Beijing Chunlizhengda Medical Instruments's P/E Ratio
Beijing Chunlizhengda Medical Instruments's P/E is 35.9 which is way above average (10.3) in its market. The excess cash it carries is the gravy on top its fast EPS growth. So based on this analysis we'd expect Beijing Chunlizhengda Medical Instruments to have a high P/E ratio. What is very clear is that the market has become significantly more optimistic about Beijing Chunlizhengda Medical Instruments over the last month, with the P/E ratio rising from 27.0 back then to 35.9 today. 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. So this free visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.
You might be able to find a better buy than Beijing Chunlizhengda Medical Instruments. 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).
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If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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.