To the annoyance of some shareholders, Stella International Holdings (HKG:1836) shares are down a considerable 30% in the last month. That drop has capped off a tough year for shareholders, with the share price down 37% in that time.
All else being equal, a share price drop should make a stock more 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, on certain occasions, long term focussed investors try to take advantage of pessimistic expectations to buy shares at a better price. 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.
How Does Stella International Holdings's P/E Ratio Compare To Its Peers?
Stella International Holdings's P/E is 7.86. The image below shows that Stella International Holdings has a P/E ratio that is roughly in line with the luxury industry average (7.4).
Its P/E ratio suggests that Stella International Holdings shareholders think that in the future it will perform about the same as other companies in its industry classification. So if Stella International Holdings 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
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. 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.
Notably, Stella International Holdings grew EPS by a whopping 47% in the last year. And earnings per share have improved by 5.5% annually, over the last three years. With that performance, I would expect it to have an above average P/E ratio. But earnings per share are down 4.5% per year over the last five years.
Remember: P/E Ratios Don't Consider The Balance Sheet
The 'Price' in P/E reflects the market capitalization of the company. That means it doesn't take debt or cash into account. 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.
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).
Stella International Holdings's Balance Sheet
The extra options and safety that comes with Stella International Holdings's US$65m net cash position means that it deserves a higher P/E than it would if it had a lot of net debt.
The Verdict On Stella International Holdings's P/E Ratio
Stella International Holdings trades on a P/E ratio of 7.9, which is below the HK market average of 9.1. Not only should the net cash position reduce risk, but the recent growth has been impressive. One might conclude that the market is a bit pessimistic, given the low P/E ratio. What can be absolutely certain is that the market has become more pessimistic about Stella International Holdings over the last month, with the P/E ratio falling from 11.3 back then to 7.9 today. For those who prefer invest in growth, this stock apparently offers limited promise, but the deep value investors may find the pessimism around this stock enticing.
When the market is wrong about a stock, it gives savvy investors an opportunity. If the reality for a company is not as bad as the P/E ratio indicates, then the share price should increase as the market realizes this. So this free report on the analyst consensus forecasts could help you make a master move on this stock.
But note: Stella International Holdings may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio 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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