A Rising Share Price Has Us Looking Closely At BYD Electronic (International) Company Limited’s (HKG:285) P/E Ratio

BYD Electronic (International) (HKG:285) shareholders are no doubt pleased to see that the share price has had a great month, posting a 32% gain, recovering from prior weakness. And the full year gain of 33% isn’t too shabby, either!

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. One way to gauge market expectations of a stock 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 BYD Electronic (International)

How Does BYD Electronic (International)’s P/E Ratio Compare To Its Peers?

BYD Electronic (International)’s P/E of 18.48 indicates some degree of optimism towards the stock. As you can see below, BYD Electronic (International) has a higher P/E than the average company (13.3) in the communications industry.

SEHK:285 Price Estimation Relative to Market, November 18th 2019
SEHK:285 Price Estimation Relative to Market, November 18th 2019

Its relatively high P/E ratio indicates that BYD Electronic (International) shareholders think it will perform better than other companies in its industry classification. Clearly the market expects growth, but it isn’t guaranteed. So further research is always essential. I often monitor director buying and selling.

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 even if the current P/E is high, it will reduce over time if the share price stays flat. A lower P/E should indicate the stock is cheap relative to others — and that may attract buyers.

BYD Electronic (International) saw earnings per share decrease by 32% last year. But it has grown its earnings per share by 12% per year over the last five years.

Don’t Forget: The P/E Does Not Account For Debt or Bank Deposits

It’s important to note that the P/E ratio considers the market capitalization, not the enterprise value. Thus, the metric does not reflect cash or debt held by the company. 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).

While growth expenditure doesn’t always pay off, the point is that it is a good option to have; but one that the P/E ratio ignores.

BYD Electronic (International)’s Balance Sheet

Since BYD Electronic (International) holds net cash of CN¥2.5b, it can spend on growth, justifying a higher P/E ratio than otherwise.

The Verdict On BYD Electronic (International)’s P/E Ratio

BYD Electronic (International)’s P/E is 18.5 which is above average (10.1) in its market. The recent drop in earnings per share would make some investors cautious, but the net cash position means the company has time to improve: and the high P/E suggests the market thinks it will. What is very clear is that the market has become more optimistic about BYD Electronic (International) over the last month, with the P/E ratio rising from 14.0 back then to 18.5 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.

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 BYD Electronic (International). 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.