Unfortunately for some shareholders, the China Hongqiao Group (HKG:1378) share price has dived 31% 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. 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. So, on certain occasions, long term focussed investors try to take advantage of pessimistic expectations to buy shares at a better price. 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). A high P/E implies that investors have high expectations of what a company can achieve compared to a company with a low P/E ratio.
Does China Hongqiao Group Have A Relatively High Or Low P/E For Its Industry?
China Hongqiao Group's P/E of 3.72 indicates relatively low sentiment towards the stock. We can see in the image below that the average P/E (8.1) for companies in the metals and mining industry is higher than China Hongqiao Group's P/E.
China Hongqiao Group's P/E tells us that market participants think it will not fare as well as its peers in the same industry. Many investors like to buy stocks when the market is pessimistic about their prospects. You should delve deeper. I like to check if company insiders have been buying or selling.
How Growth Rates Impact P/E Ratios
Earnings growth rates have a big influence on P/E ratios. That's because companies that grow earnings per share quickly will rapidly increase the 'E' in the equation. And in that case, the P/E ratio itself will drop rather quickly. And as that P/E ratio drops, the company will look cheap, unless its share price increases.
China Hongqiao Group saw earnings per share improve by 3.8% last year. And it has improved its earnings per share by 3.1% per year over the last three years. In contrast, EPS has decreased by 3.0%, annually, over 5 years.
Remember: P/E Ratios Don't Consider The Balance Sheet
The 'Price' in P/E reflects the market capitalization of the company. 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.
Such expenditure might be good or bad, in the long term, but the point here is that the balance sheet is not reflected by this ratio.
So What Does China Hongqiao Group's Balance Sheet Tell Us?
China Hongqiao Group's net debt is considerable, at 223% of its market cap. This level of debt justifies a relatively low P/E, so remain cognizant of the debt, if you're comparing it to other stocks.
The Verdict On China Hongqiao Group's P/E Ratio
China Hongqiao Group has a P/E of 3.7. That's below the average in the HK market, which is 8.6. It's good to see EPS growth in the last 12 months, but the debt on the balance sheet might be muting expectations. What can be absolutely certain is that the market has become more pessimistic about China Hongqiao Group over the last month, with the P/E ratio falling from 5.4 back then to 3.7 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 should be looking to buy stocks that the market is wrong about. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. So this free report on the analyst consensus forecasts could help you make a master move on this stock.
But note: China Hongqiao Group 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.
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. Thank you for reading.