What Is MECOM Power and Construction’s (HKG:1183) P/E Ratio After Its Share Price Rocketed?

MECOM Power and Construction (HKG:1183) shares have continued recent momentum with a 31% gain in the last month alone. And the full year gain of 12% isn’t too shabby, either!

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. 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.

See our latest analysis for MECOM Power and Construction

Does MECOM Power and Construction Have A Relatively High Or Low P/E For Its Industry?

MECOM Power and Construction’s P/E of 37.52 indicates some degree of optimism towards the stock. The image below shows that MECOM Power and Construction has a significantly higher P/E than the average (9.7) P/E for companies in the construction industry.

SEHK:1183 Price Estimation Relative to Market, January 1st 2020
SEHK:1183 Price Estimation Relative to Market, January 1st 2020

MECOM Power and Construction’s P/E tells us that market participants think the company will perform better than its industry peers, going forward. Shareholders are clearly optimistic, but the future is always uncertain. So investors should delve deeper. I like to check if company insiders have been buying or selling.

How Growth Rates Impact P/E Ratios

When earnings fall, the ‘E’ decreases, over time. That means even if the current P/E is low, it will increase over time if the share price stays flat. A higher P/E should indicate the stock is expensive relative to others — and that may encourage shareholders to sell.

MECOM Power and Construction shrunk earnings per share by 49% over the last year. And over the longer term (5 years) earnings per share have decreased 16% annually. This growth rate might warrant a below average P/E ratio.

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

One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. 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).

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.

So What Does MECOM Power and Construction’s Balance Sheet Tell Us?

MECOM Power and Construction has net cash of MO$270m. This is fairly high at 19% of its market capitalization. That might mean balance sheet strength is important to the business, but should also help push the P/E a bit higher than it would otherwise be.

The Verdict On MECOM Power and Construction’s P/E Ratio

MECOM Power and Construction’s P/E is 37.5 which is way above average (10.5) in its market. The recent drop in earnings per share might keep value investors away, but the relatively strong balance sheet will allow the company time to invest in growth. Clearly, the high P/E indicates shareholders think it will! What we know for sure is that investors have become much more excited about MECOM Power and Construction recently, since they have pushed its P/E ratio from 28.6 to 37.5 over the last month. 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.

Investors have an opportunity when market expectations about a stock are wrong. 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. We don’t have analyst forecasts, but you might want to assess this data-rich visualization of earnings, revenue and cash flow.

Of course you might be able to find a better stock than MECOM Power and Construction. 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.