Shanghai Haohai Biological Technology (HKG:6826) shareholders are no doubt pleased to see that the share price has had a great month, posting a 36% gain, recovering from prior weakness. However, the annual gain of 2.5% wasn't so impressive.
All else being equal, a sharp share price increase should make a stock less attractive to potential investors. 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. 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). A high P/E implies that investors have high expectations of what a company can achieve compared to a company with a low P/E ratio.
How Does Shanghai Haohai Biological Technology's P/E Ratio Compare To Its Peers?
Shanghai Haohai Biological Technology has a P/E ratio of 18.31. As you can see below Shanghai Haohai Biological Technology has a P/E ratio that is fairly close for the average for the biotechs industry, which is 17.3.
Its P/E ratio suggests that Shanghai Haohai Biological Technology shareholders think that in the future it will perform about the same as other companies in its industry classification. So if Shanghai Haohai Biological Technology actually outperforms its peers going forward, that should be a positive for the share price. Further research into factors such as insider buying and selling, could help you form your own view on whether that is likely.
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. That means unless the share price increases, the P/E will reduce in a few years. And as that P/E ratio drops, the company will look cheap, unless its share price increases.
Shanghai Haohai Biological Technology's earnings per share fell by 5.5% in the last twelve months. But over the longer term (5 years) earnings per share have increased by 13%.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
The 'Price' in P/E reflects the market capitalization of the company. In other words, it does not consider any debt or cash that the company may have on the balance sheet. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
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.
Shanghai Haohai Biological Technology's Balance Sheet
Shanghai Haohai Biological Technology has net cash of CN¥1.5b. This is fairly high at 23% of its market capitalization. That might mean balance sheet strength is important to the business, but should also help push the P/E a bit higher than it would otherwise be.
The Bottom Line On Shanghai Haohai Biological Technology's P/E Ratio
Shanghai Haohai Biological Technology has a P/E of 18.3. That's higher than the average in its market, which is 10.3. The recent drop in earnings per share would make some investors cautious, but the relatively strong balance sheet will allow the company time to invest in growth. Clearly, the high P/E indicates shareholders think it will! What is very clear is that the market has become more optimistic about Shanghai Haohai Biological Technology over the last month, with the P/E ratio rising from 13.5 back then to 18.3 today. For those who prefer to invest with the flow of momentum, that might mean it's time to put the stock on a watchlist, or research it. But the contrarian may see it as a missed opportunity.
Investors should be looking to buy stocks that the market is wrong about. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.
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.