Royale Furniture Holdings (HKG:1198) shares have had a really impressive month, gaining 34%, after some slippage. The full year gain of 46% is pretty reasonable, too.
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). 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.
How Does Royale Furniture Holdings's P/E Ratio Compare To Its Peers?
Royale Furniture Holdings's P/E of 53.72 indicates some degree of optimism towards the stock. The image below shows that Royale Furniture Holdings has a significantly higher P/E than the average (10.0) P/E for companies in the consumer durables industry.
Its relatively high P/E ratio indicates that Royale Furniture Holdings shareholders think it will perform better than other companies in its industry classification. The market is optimistic about the future, but that doesn't guarantee future growth. 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
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. And as that P/E ratio drops, the company will look cheap, unless its share price increases.
Royale Furniture Holdings's earnings per share grew by 4.0% in the last twelve months. And earnings per share have improved by 3.8% annually, over the last three years.
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. In other words, it does not consider any debt or cash that the company may have on the balance sheet. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
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).
How Does Royale Furniture Holdings's Debt Impact Its P/E Ratio?
The extra options and safety that comes with Royale Furniture Holdings's HK$190m net cash position means that it deserves a higher P/E than it would if it had a lot of net debt.
The Bottom Line On Royale Furniture Holdings's P/E Ratio
Royale Furniture Holdings's P/E is 53.7 which suggests the market is more focussed on the future opportunity rather than the current level of earnings. EPS was up modestly better over the last twelve months. And the healthy balance sheet means the company can sustain growth while the P/E suggests shareholders think it will. What we know for sure is that investors have become much more excited about Royale Furniture Holdings recently, since they have pushed its P/E ratio from 40.2 to 53.7 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.
Investors should be looking to buy stocks that the market is wrong about. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. We don't have analyst forecasts, but 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.
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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