Unfortunately for some shareholders, the Somerley Capital Holdings (HKG:8439) share price has dived 36% in the last thirty days. The recent drop has obliterated the annual return, with the share price now down 25% over that longer period.
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). Investors have optimistic expectations of companies with higher P/E ratios, compared to companies with lower P/E ratios.
Does Somerley Capital Holdings Have A Relatively High Or Low P/E For Its Industry?
Somerley Capital Holdings's P/E of 24.17 indicates some degree of optimism towards the stock. The image below shows that Somerley Capital Holdings has a higher P/E than the average (12.1) P/E for companies in the capital markets industry.
Its relatively high P/E ratio indicates that Somerley Capital Holdings shareholders think it will perform better than other companies in its industry classification. The market is optimistic about the future, but that doesn't guarantee future growth. So further research is always essential. I often monitor director buying and 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. Earnings growth means that in the future the 'E' will be higher. That means even if the current P/E is high, it will reduce over time if the share price stays flat. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.
Somerley Capital Holdings increased earnings per share by an impressive 25% over the last twelve months. And its annual EPS growth rate over 3 years is 47%. With that performance, you might expect an above average P/E ratio.
Remember: P/E Ratios Don't Consider The Balance Sheet
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. Thus, the metric does not reflect cash or debt held by the company. 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).
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.
How Does Somerley Capital Holdings's Debt Impact Its P/E Ratio?
With net cash of HK$102m, Somerley Capital Holdings has a very strong balance sheet, which may be important for its business. Having said that, at 47% of its market capitalization the cash hoard would contribute towards a higher P/E ratio.
The Bottom Line On Somerley Capital Holdings's P/E Ratio
Somerley Capital Holdings's P/E is 24.2 which is above average (10.3) in its market. Its strong balance sheet gives the company plenty of resources for extra growth, and it has already proven it can grow. So it does not seem strange that the P/E is above average. Given Somerley Capital Holdings's P/E ratio has declined from 37.9 to 24.2 in the last month, we know for sure that the market is significantly less confident about the business today, than it was back then. For those who don't like to trade against momentum, that could be a warning sign, but a contrarian investor might want to take a closer look.
Investors should be looking to buy stocks that the market is wrong about. 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 might want to assess this data-rich visualization of earnings, revenue and cash flow.
Of course you might be able to find a better stock than Somerley Capital Holdings. So you may wish to see this free collection of other companies that have grown earnings strongly.
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.