To the annoyance of some shareholders, Chanhigh Holdings (HKG:2017) shares are down a considerable 35% in the last month. Indeed the recent decline has arguably caused some bitterness for shareholders who have held through the 45% drop over twelve months.
Assuming nothing else has changed, a lower share price makes a stock more attractive to potential buyers. 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. 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 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 Chanhigh Holdings Have A Relatively High Or Low P/E For Its Industry?
Chanhigh Holdings has a P/E ratio of 10.25. You can see in the image below that the average P/E (10.4) for companies in the construction industry is roughly the same as Chanhigh Holdings's P/E.
Chanhigh Holdings's P/E tells us that market participants think its prospects are roughly in line with its industry. If the company has better than average prospects, then the market might be underestimating it. I would further inform my view by checking insider buying and selling., among other things.
How Growth Rates Impact P/E Ratios
If earnings fall then in the future the 'E' will be lower. That means unless the share price falls, the P/E will increase in a few years. So while a stock may look cheap based on past earnings, it could be expensive based on future earnings.
Chanhigh Holdings shrunk earnings per share by 43% over the last year. And over the longer term (3 years) earnings per share have decreased 47% annually. This could justify a low P/E.
Remember: P/E Ratios Don't Consider The Balance Sheet
It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. 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.
While growth expenditure doesn't always pay off, the point is that it is a good option to have; but one that the P/E ratio ignores.
Chanhigh Holdings's Balance Sheet
Chanhigh Holdings has net debt worth 22% of its market capitalization. It would probably deserve a higher P/E ratio if it was net cash, since it would have more options for growth.
The Verdict On Chanhigh Holdings's P/E Ratio
Chanhigh Holdings trades on a P/E ratio of 10.2, which is fairly close to the HK market average of 10.4. With modest debt, and a lack of recent growth, it would seem the market is expecting improvement in earnings. What can be absolutely certain is that the market has become significantly less optimistic about Chanhigh Holdings over the last month, with the P/E ratio falling from 15.7 back then to 10.2 today. For those who prefer to invest with the flow of momentum, that might be a bad sign, but for a contrarian, it may signal opportunity.
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. We don't have analyst forecasts, but 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 find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.
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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. Thank you for reading.