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A Sliding Share Price Has Us Looking At Linocraft Holdings Limited's (HKG:8383) P/E Ratio

Simply Wall St

Unfortunately for some shareholders, the Linocraft Holdings (HKG:8383) share price has dived 40% in the last thirty days. And that drop will have no doubt have some shareholders concerned that the 78% share price decline, over the last year, has turned them into bagholders. For those wondering, a bagholder is someone who keeps holding a losing stock indefinitely, without taking the time to consider its prospects carefully, going forward.

Assuming nothing else has changed, a lower share price makes a stock more attractive to potential buyers. 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. 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.

Check out our latest analysis for Linocraft Holdings

Does Linocraft Holdings Have A Relatively High Or Low P/E For Its Industry?

We can tell from its P/E ratio of 2.84 that sentiment around Linocraft Holdings isn't particularly high. The image below shows that Linocraft Holdings has a lower P/E than the average (10.6) P/E for companies in the commercial services industry.

SEHK:8383 Price Estimation Relative to Market, March 24th 2020

This suggests that market participants think Linocraft Holdings will underperform other companies in its industry. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. If you consider the stock interesting, further research is recommended. For example, 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. Therefore, even if you pay a low multiple of earnings now, that multiple will become higher in the future. A higher P/E should indicate the stock is expensive relative to others -- and that may encourage shareholders to sell.

Linocraft Holdings increased earnings per share by 9.4% last year. In contrast, EPS has decreased by 13%, annually, over 3 years.

Remember: P/E Ratios Don't Consider The Balance Sheet

The 'Price' in P/E reflects the market capitalization of the company. 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).

So What Does Linocraft Holdings's Balance Sheet Tell Us?

Linocraft Holdings has net debt worth a very significant 320% of its market capitalization. This is a relatively high level of debt, so the stock probably deserves a relatively low P/E ratio. Keep that in mind when comparing it to other companies.

The Verdict On Linocraft Holdings's P/E Ratio

Linocraft Holdings's P/E is 2.8 which is below average (8.3) in the HK market. 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 Linocraft Holdings over the last month, with the P/E ratio falling from 4.7 back then to 2.8 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.

When the market is wrong about a stock, it gives savvy investors an opportunity. If the reality for a company is not as bad as the P/E ratio indicates, then the share price should increase as the market realizes this. 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.

Of course you might be able to find a better stock than Linocraft Holdings. 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 editorial-team@simplywallst.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.