Zhejiang Cangnan Instrument Group (HKG:1743) shares have continued recent momentum with a 35% gain in the last month alone. The full year gain of 45% is pretty reasonable, too.
Assuming no other changes, a sharply higher share price makes a stock less 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). So some would prefer to hold off buying when there is a lot of optimism towards a stock. One way to gauge market expectations of a stock 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 Zhejiang Cangnan Instrument Group Have A Relatively High Or Low P/E For Its Industry?
Zhejiang Cangnan Instrument Group's P/E of 5.76 indicates relatively low sentiment towards the stock. If you look at the image below, you can see Zhejiang Cangnan Instrument Group has a lower P/E than the average (9.8) in the electronic industry classification.
Zhejiang Cangnan Instrument 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. Then, a lower P/E should attract more buyers, pushing the share price up.
Zhejiang Cangnan Instrument Group's earnings per share fell by 25% in the last twelve months. But it has grown its earnings per share by 38% per year over the last five years.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. So it won't reflect the advantage of cash, or disadvantage of debt. The exact same company would hypothetically deserve a higher P/E ratio if it had a strong balance sheet, than if it had a weak one with lots of debt, because a cashed up company can spend on growth.
Such spending might be good or bad, overall, but the key point here is that you need to look at debt to understand the P/E ratio in context.
How Does Zhejiang Cangnan Instrument Group's Debt Impact Its P/E Ratio?
With net cash of CN¥484m, Zhejiang Cangnan Instrument Group has a very strong balance sheet, which may be important for its business. Having said that, at 39% of its market capitalization the cash hoard would contribute towards a higher P/E ratio.
The Bottom Line On Zhejiang Cangnan Instrument Group's P/E Ratio
Zhejiang Cangnan Instrument Group's P/E is 5.8 which is below average (10.6) in the HK market. Falling earnings per share are likely to be keeping potential buyers away, but the net cash position means the company has time to improve: if so, the low P/E could be an opportunity. What we know for sure is that investors are becoming less uncomfortable about Zhejiang Cangnan Instrument Group's prospects, since they have pushed its P/E ratio from 4.3 to 5.8 over the last month. If you like to buy stocks that could be turnaround opportunities, then this one might be a candidate; but if you're more sensitive to price, then you may feel the opportunity has passed.
When the market is wrong about a stock, it gives savvy investors an opportunity. 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 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.
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.
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