A Rising Share Price Has Us Looking Closely At Minth Group Limited's (HKG:425) P/E Ratio

Simply Wall St

Minth Group (HKG:425) shares have had a really impressive month, gaining 33%, after some slippage. But shareholders may not all be feeling jubilant, since the share price is still down 24% in the last year.

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). So some would prefer to hold off buying when there is a lot of optimism towards a stock. 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). A high P/E ratio means that investors have a high expectation about future growth, while a low P/E ratio means they have low expectations about future growth.

View our latest analysis for Minth Group

Does Minth Group Have A Relatively High Or Low P/E For Its Industry?

We can tell from its P/E ratio of 16.85 that there is some investor optimism about Minth Group. You can see in the image below that the average P/E (11.6) for companies in the auto components industry is lower than Minth Group's P/E.

SEHK:425 Price Estimation Relative to Market, September 21st 2019

That means that the market expects Minth Group will outperform other companies in its industry. Shareholders are clearly optimistic, but the future is always uncertain. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.

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. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. 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.

Minth Group shrunk earnings per share by 20% over the last year. But over the longer term (5 years) earnings per share have increased by 7.6%.

A Limitation: P/E Ratios Ignore Debt and Cash In The Bank

The 'Price' in P/E reflects the market capitalization of the company. Thus, the metric does not reflect cash or debt held by the company. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.

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).

Minth Group's Balance Sheet

Minth Group has net cash of CN¥913m. That should lead to a higher P/E than if it did have debt, because its strong balance sheets gives it more options.

The Verdict On Minth Group's P/E Ratio

Minth Group trades on a P/E ratio of 16.8, which is above its market average of 10.5. The recent drop in earnings per share would make some investors cautious, but the healthy balance sheet means the company retains potential for future growth. If fails to eventuate, the current high P/E could prove to be temporary, as the share price falls. What is very clear is that the market has become more optimistic about Minth Group over the last month, with the P/E ratio rising from 12.7 back then to 16.8 today. If you like to buy stocks that have recently impressed the market, then this one might be a candidate; but if you prefer to invest when there is 'blood in the streets', 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. So this free visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.

You might be able to find a better buy than Minth Group. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).

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 editorial-team@simplywallst.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.