Unfortunately for some shareholders, the Zhongyuan Bank (HKG:1216) share price has dived 31% in the last thirty days. Indeed the recent decline has arguably caused some bitterness for shareholders who have held through the 50% drop over twelve months.
All else being equal, a share price drop should make a stock more attractive to potential investors. 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. 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). Investors have optimistic expectations of companies with higher P/E ratios, compared to companies with lower P/E ratios.
How Does Zhongyuan Bank's P/E Ratio Compare To Its Peers?
We can tell from its P/E ratio of 8.19 that there is some investor optimism about Zhongyuan Bank. As you can see below, Zhongyuan Bank has a higher P/E than the average company (6.0) in the banks industry.
That means that the market expects Zhongyuan Bank will outperform other companies in its industry. Clearly the market expects growth, but it isn't guaranteed. 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
When earnings fall, the 'E' decreases, over time. That means even if the current P/E is low, it will increase over time if the share price stays flat. Then, a higher P/E might scare off shareholders, pushing the share price down.
Zhongyuan Bank shrunk earnings per share by 34% over the last year. And it has shrunk its earnings per share by 12% per year over the last three years. This might lead to low expectations.
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. 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).
How Does Zhongyuan Bank's Debt Impact Its P/E Ratio?
Net debt totals 78% of Zhongyuan Bank's 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 Zhongyuan Bank's P/E Ratio
Zhongyuan Bank has a P/E of 8.2. That's below the average in the HK market, which is 10.5. When you consider that the company has significant debt, and didn't grow EPS last year, it isn't surprising that the market has muted expectations. Given Zhongyuan Bank's P/E ratio has declined from 11.9 to 8.2 in the last month, we know for sure that the market is more worried about the business today, than it was back then. For those who prefer invest in growth, this stock apparently offers limited promise, but the deep value investors may find the pessimism around this stock enticing.
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. Although we don't have analyst forecasts you could get a better understanding of its growth by checking out this more detailed historical graph of earnings, revenue and cash flow.
You might be able to find a better buy than Zhongyuan Bank. 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 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.