The Justin Allen Holdings (HKG:1425) share price has done well in the last month, posting a gain of 32%. While recent buyers might be laughing, long term holders might not be so pleased, since the recent gain only brings the full year return to evens.

All else being equal, a sharp share price increase should make a stock less 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). The implication here is that deep value investors might steer clear when expectations of a company are too high. 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.

See our latest analysis for Justin Allen Holdings

How Does Justin Allen Holdings's P/E Ratio Compare To Its Peers?

Justin Allen Holdings has a P/E ratio of 7.18. The image below shows that Justin Allen Holdings has a P/E ratio that is roughly in line with the luxury industry average (7.1).

Justin Allen Holdings's P/E tells us that market participants think its prospects are roughly in line with its industry. The company could surprise by performing better than average, in the future. 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. And in that case, the P/E ratio itself will drop rather quickly. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.

Most would be impressed by Justin Allen Holdings earnings growth of 24% in the last year. And it has bolstered its earnings per share by 2.3% per year over the last five years. So one might expect an above average P/E ratio.

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. In other words, it does not consider any debt or cash that the company may have on the balance sheet. 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).

Spending on growth might be good or bad a few years later, but the point is that the P/E ratio does not account for the option (or lack thereof).

Justin Allen Holdings's Balance Sheet

Since Justin Allen Holdings holds net cash of HK$20m, it can spend on growth, justifying a higher P/E ratio than otherwise.

The Verdict On Justin Allen Holdings's P/E Ratio

Justin Allen Holdings trades on a P/E ratio of 7.2, which is below the HK market average of 9.3. The net cash position gives plenty of options to the business, and the recent improvement in EPS is good to see. The relatively low P/E ratio implies the market is pessimistic. What we know for sure is that investors are becoming less uncomfortable about Justin Allen Holdings's prospects, since they have pushed its P/E ratio from 5.4 to 7.2 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.

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. Although we don't have analyst forecasts shareholders might want to examine this detailed historical graph of earnings, revenue and cash flow.

Of course you might be able to find a better stock than Justin Allen Holdings. So you may wish to see this free collection of other companies that have grown earnings strongly.

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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. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned. Thank you for reading.