TK Group (Holdings) (HKG:2283) shareholders are no doubt pleased to see that the share price has had a great month, posting a 37% gain, recovering from prior weakness. But shareholders may not all be feeling jubilant, since the share price is still down 26% in the last year.
Assuming no other changes, a sharply higher share price makes a stock less attractive to potential buyers. 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). Investors have optimistic expectations of companies with higher P/E ratios, compared to companies with lower P/E ratios.
Does TK Group (Holdings) Have A Relatively High Or Low P/E For Its Industry?
We can tell from its P/E ratio of 9.7 that sentiment around TK Group (Holdings) isn’t particularly high. The image below shows that TK Group (Holdings) has a lower P/E than the average (10.5) P/E for companies in the machinery industry.
Its relatively low P/E ratio indicates that TK Group (Holdings) shareholders think it will struggle to do as well as other companies in its industry classification.
How Growth Rates Impact P/E Ratios
Probably the most important factor in determining what P/E a company trades on is the earnings growth. Earnings growth means that in the future the ‘E’ will be higher. That means even if the current P/E is high, it will reduce over time if the share price stays flat. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
TK Group (Holdings)’s earnings per share fell by 2.4% in the last twelve months. But it has grown its earnings per share by 16% 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. So it won’t reflect the advantage of cash, or disadvantage of debt. 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).
Such expenditure might be good or bad, in the long term, but the point here is that the balance sheet is not reflected by this ratio.
Is Debt Impacting TK Group (Holdings)’s P/E?
TK Group (Holdings) has net cash of HK$173m. That should lead to a higher P/E than if it did have debt, because its strong balance sheets gives it more options.
The Bottom Line On TK Group (Holdings)’s P/E Ratio
TK Group (Holdings)’s P/E is 9.7 which is below average (10.7) in the HK market. Falling earnings per share are likely to be keeping potential buyers away, the relatively strong balance sheet will allow the company time to invest in growth. If it achieves that, then there’s real potential that the low P/E could eventually indicate undervaluation. What is very clear is that the market has become significantly less pessimistic about TK Group (Holdings) over the last month, with the P/E ratio rising from 7.1 back then to 9.7 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. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.
You might be able to find a better buy than TK Group (Holdings). 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).
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If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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.