To the annoyance of some shareholders, Dadi Early-Childhood Education Group (GTSM:8437) shares are down a considerable 31% in the last month. Even longer term holders have taken a real hit with the stock declining 21% in the last year.
Assuming nothing else has changed, a lower share price makes a stock more 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. 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). 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.
Does Dadi Early-Childhood Education Group Have A Relatively High Or Low P/E For Its Industry?
We can tell from its P/E ratio of 11.54 that there is some investor optimism about Dadi Early-Childhood Education Group. You can see in the image below that the average P/E (10.7) for companies in the consumer services industry is lower than Dadi Early-Childhood Education Group’s P/E.
That means that the market expects Dadi Early-Childhood Education Group will outperform other companies in its industry. Shareholders are clearly optimistic, but the future is always uncertain. 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. 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. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
It’s great to see that Dadi Early-Childhood Education Group grew EPS by 16% in the last year. And its annual EPS growth rate over 5 years is 21%. This could arguably justify a relatively high P/E ratio.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
Don’t forget that the P/E ratio considers market capitalization. Thus, the metric does not reflect cash or debt held by the company. 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.
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.
Is Debt Impacting Dadi Early-Childhood Education Group’s P/E?
With net cash of NT$1.1b, Dadi Early-Childhood Education Group has a very strong balance sheet, which may be important for its business. Having said that, at 15% of its market capitalization the cash hoard would contribute towards a higher P/E ratio.
The Verdict On Dadi Early-Childhood Education Group’s P/E Ratio
Dadi Early-Childhood Education Group has a P/E of 11.5. That’s below the average in the TW market, which is 12.8. The net cash position gives plenty of options to the business, and the recent improvement in EPS is good to see. One might conclude that the market is a bit pessimistic, given the low P/E ratio. Given analysts are expecting further growth, one I would have expected a higher P/E ratio. So this stock may well be worth further research. What can be absolutely certain is that the market has become significantly less optimistic about Dadi Early-Childhood Education Group over the last month, with the P/E ratio falling from 16.8 back then to 11.5 today. For those who don’t like to trade against momentum, that could be a warning sign, but a contrarian investor might want to take a closer look.
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 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 Dadi Early-Childhood Education Group. 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).
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.
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