Unfortunately for some shareholders, the Towngas China (HKG:1083) share price has dived 34% in the last thirty days. That drop has capped off a tough year for shareholders, with the share price down 47% in that time.
All else being equal, a share price drop should make a stock more 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). The implication here is that long term investors have an opportunity when expectations of a company are too low. One way to gauge market expectations of a stock 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.
Does Towngas China Have A Relatively High Or Low P/E For Its Industry?
Towngas China's P/E of 7.14 indicates relatively low sentiment towards the stock. We can see in the image below that the average P/E (13.0) for companies in the gas utilities industry is higher than Towngas China's P/E.
Its relatively low P/E ratio indicates that Towngas China shareholders think it will struggle to do as well as other companies in its industry classification. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. You should delve deeper. I like to check if company insiders have been buying or selling.
How Growth Rates Impact P/E Ratios
Generally speaking the rate of earnings growth has a profound impact on a company's P/E multiple. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. And in that case, the P/E ratio itself will drop rather quickly. Then, a lower P/E should attract more buyers, pushing the share price up.
Towngas China increased earnings per share by 5.0% last year. And its annual EPS growth rate over 5 years is 2.8%.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
Don't forget that the P/E ratio considers market capitalization. Thus, the metric does not reflect cash or debt held by the company. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.
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.
Towngas China's Balance Sheet
Towngas China's net debt is 82% of its market cap. This is a reasonably significant level of debt -- all else being equal you'd expect a much lower P/E than if it had net cash.
The Verdict On Towngas China's P/E Ratio
Towngas China's P/E is 7.1 which is below average (8.6) in the HK market. The meaningful debt load is probably contributing to low expectations, even though it has improved earnings recently. What can be absolutely certain is that the market has become more pessimistic about Towngas China over the last month, with the P/E ratio falling from 10.8 back then to 7.1 today. For those who prefer to invest with the flow of momentum, that might be a bad sign, but for deep value investors this stock might justify some research.
Investors have an opportunity when market expectations about a stock are wrong. 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 visual report on analyst forecasts could hold the key to an excellent investment decision.
But note: Towngas China may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio 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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