It's great to see Shenglong Splendecor International (HKG:8481) shareholders have their patience rewarded with a 87% share price pop in the last month. The full year gain of 49% 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. 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.
How Does Shenglong Splendecor International's P/E Ratio Compare To Its Peers?
Shenglong Splendecor International's P/E of 15.32 indicates some degree of optimism towards the stock. You can see in the image below that the average P/E (12.3) for companies in the commercial services industry is lower than Shenglong Splendecor International's P/E.
Shenglong Splendecor International'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
Companies that shrink earnings per share quickly will rapidly decrease the 'E' in the equation. That means even if the current P/E is low, it will increase over time if the share price stays flat. A higher P/E should indicate the stock is expensive relative to others -- and that may encourage shareholders to sell.
In the last year, Shenglong Splendecor International grew EPS like Taylor Swift grew her fan base back in 2010; the 170% gain was both fast and well deserved. Regrettably, the longer term performance is poor, with EPS down -1.1% per year over 3 years.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. 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 Shenglong Splendecor International's P/E?
Shenglong Splendecor International's net debt is 73% of its market cap. This is enough debt that you'd have to make some adjustments before using the P/E ratio to compare it to a company with net cash.
The Verdict On Shenglong Splendecor International's P/E Ratio
Shenglong Splendecor International trades on a P/E ratio of 15.3, which is above its market average of 10.5. Its meaningful level of debt should warrant a lower P/E ratio, but the fast EPS growth is a positive. So despite the debt it is, perhaps, not unreasonable to see a high P/E ratio. What is very clear is that the market has become significantly more optimistic about Shenglong Splendecor International over the last month, with the P/E ratio rising from 8.2 back then to 15.3 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.
When the market is wrong about a stock, it gives savvy investors an opportunity. 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. We don't have analyst forecasts, but shareholders might want to examine this detailed historical graph of earnings, revenue and cash flow.
Of course you might be able to find a better stock than Shenglong Splendecor International. So you may wish to see this free collection of other companies that have grown earnings strongly.
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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