A Rising Share Price Has Us Looking Closely At China Sanjiang Fine Chemicals Company Limited's (HKG:2198) P/E Ratio
China Sanjiang Fine Chemicals (HKG:2198) shareholders are no doubt pleased to see that the share price has had a great month, posting a 32% gain, recovering from prior weakness. But shareholders may not all be feeling jubilant, since the share price is still down 28% in the last year.
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. 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). 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.
See our latest analysis for China Sanjiang Fine Chemicals
How Does China Sanjiang Fine Chemicals's P/E Ratio Compare To Its Peers?
We can tell from its P/E ratio of 3.14 that sentiment around China Sanjiang Fine Chemicals isn't particularly high. If you look at the image below, you can see China Sanjiang Fine Chemicals has a lower P/E than the average (6.6) in the chemicals industry classification.
This suggests that market participants think China Sanjiang Fine Chemicals will underperform other companies in its industry. Since the market seems unimpressed with China Sanjiang Fine Chemicals, it's quite possible it could surprise on the upside. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.
How Growth Rates Impact P/E Ratios
If earnings fall then in the future the 'E' will be lower. Therefore, even if you pay a low multiple of earnings now, that multiple will become higher in the future. A higher P/E should indicate the stock is expensive relative to others -- and that may encourage shareholders to sell.
It's great to see that China Sanjiang Fine Chemicals grew EPS by 20% in the last year. And it has bolstered its earnings per share by 28% per year over the last five years. With that performance, you might expect an above average P/E ratio. But earnings per share are down 6.0% per year over the last three years.
Remember: P/E Ratios Don't Consider The Balance Sheet
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. That means it doesn't take debt or cash into account. In theory, a company can lower its future P/E ratio by using cash or debt to invest in 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.
China Sanjiang Fine Chemicals's Balance Sheet
China Sanjiang Fine Chemicals has net debt worth a very significant 144% of its market capitalization. This is a relatively high level of debt, so the stock probably deserves a relatively low P/E ratio. Keep that in mind when comparing it to other companies.
The Bottom Line On China Sanjiang Fine Chemicals's P/E Ratio
China Sanjiang Fine Chemicals trades on a P/E ratio of 3.1, which is below the HK market average of 9.5. The company has a meaningful amount of debt on the balance sheet, but that should not eclipse the solid earnings growth. If the company can continue to grow earnings, then the current P/E may be unjustifiably low. What is very clear is that the market has become less pessimistic about China Sanjiang Fine Chemicals over the last month, with the P/E ratio rising from 2.4 back then to 3.1 today. 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 should be looking to buy stocks that the market is wrong about. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. 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 China Sanjiang Fine Chemicals. So you may wish to see this free collection of other companies that have grown earnings strongly.
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.
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. Thank you for reading.
