To the annoyance of some shareholders, Stella International Holdings (HKG:1836) shares are down a considerable 32% in the last month. That drop has capped off a tough year for shareholders, with the share price down 38% in that time.
All else being equal, a share price drop should make a stock more attractive to potential investors. 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). 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). Investors have optimistic expectations of companies with higher P/E ratios, compared to companies with lower P/E ratios.
How Does Stella International Holdings's P/E Ratio Compare To Its Peers?
Stella International Holdings's P/E of 7.74 indicates some degree of optimism towards the stock. As you can see below, Stella International Holdings has a higher P/E than the average company (7.0) in the luxury industry.
That means that the market expects Stella International Holdings will outperform other companies in its industry. The market is optimistic about the future, but that doesn't guarantee future growth. So investors should delve deeper. I like to check if company insiders have been buying or selling.
How Growth Rates Impact P/E Ratios
P/E ratios primarily reflect market expectations around earnings growth rates. When earnings grow, the 'E' increases, over time. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.
Stella International Holdings increased earnings per share by a whopping 47% last year. And its annual EPS growth rate over 3 years is 5.5%. So we'd generally expect it to have a relatively high P/E ratio. In contrast, EPS has decreased by 4.5%, annually, over 5 years.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. So it won't reflect the advantage of cash, or disadvantage of debt. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
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.
So What Does Stella International Holdings's Balance Sheet Tell Us?
Since Stella International Holdings holds net cash of US$65m, it can spend on growth, justifying a higher P/E ratio than otherwise.
The Bottom Line On Stella International Holdings's P/E Ratio
Stella International Holdings's P/E is 7.7 which is below average (8.6) in the HK market. Not only should the net cash position reduce risk, but the recent growth has been impressive. The below average P/E ratio suggests that market participants don't believe the strong growth will continue. What can be absolutely certain is that the market has become more pessimistic about Stella International Holdings over the last month, with the P/E ratio falling from 11.3 back then to 7.7 today. 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. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.
But note: Stella International Holdings 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 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.
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