A Rising Share Price Has Us Looking Closely At SCUD Group Limited’s (HKG:1399) P/E Ratio

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SCUD Group (HKG:1399) shares have had a really impressive month, gaining 36%, after some slippage. While recent buyers might be laughing, long term holders might not be so pleased, since the recent gain only brings the full year return to evens.

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.

View our latest analysis for SCUD Group

How Does SCUD Group’s P/E Ratio Compare To Its Peers?

SCUD Group’s P/E of 4.12 indicates relatively low sentiment towards the stock. The image below shows that SCUD Group has a lower P/E than the average (11.4) P/E for companies in the electrical industry.

SEHK:1399 Price Estimation Relative to Market, July 10th 2019
SEHK:1399 Price Estimation Relative to Market, July 10th 2019

Its relatively low P/E ratio indicates that SCUD Group 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. If earnings are growing quickly, then the ‘E’ in the equation will increase faster than it would otherwise. That means even if the current P/E is high, it will reduce over time if the share price stays flat. And as that P/E ratio drops, the company will look cheap, unless its share price increases.

SCUD Group’s earnings made like a rocket, taking off 342% last year. And earnings per share have improved by 35% annually, over the last three years. So we’d absolutely expect it to have a relatively high P/E ratio.

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

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.

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).

SCUD Group’s Balance Sheet

Net debt totals 81% of SCUD Group’s market cap. This is enough debt that you’d have to make some adjustments before using the P/E ratio to compare it to a company with net cash.

The Bottom Line On SCUD Group’s P/E Ratio

SCUD Group’s P/E is 4.1 which is below average (10.8) in the HK market. The company may have significant debt, but EPS growth was good last year. If the company can continue to grow earnings, then the current P/E may be unjustifiably low. What we know for sure is that investors are becoming less uncomfortable about SCUD Group’s prospects, since they have pushed its P/E ratio from 3 to 4.1 over the last month. For those who like to invest in turnarounds, that might mean it’s time to put the stock on a watchlist, or research it. But others might consider the opportunity to have passed.

Investors have an opportunity when market expectations about a stock are wrong. 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. Although we don’t have analyst forecasts, shareholders might want to examine this detailed historical graph of earnings, revenue and cash flow.

But note: SCUD Group 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).

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.