To the annoyance of some shareholders, Ability Opto-Electronics TechnologyLtd (GTSM:3362) shares are down a considerable 31% in the last month. That drop has capped off a tough year for shareholders, with the share price down 54% in that time.
All else being equal, a share price drop should make a stock more 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). The implication here is that long term investors have an opportunity when expectations of a company are too low. 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 implies that investors have high expectations of what a company can achieve compared to a company with a low P/E ratio.
How Does Ability Opto-Electronics TechnologyLtd’s P/E Ratio Compare To Its Peers?
We can tell from its P/E ratio of 43.20 that there is some investor optimism about Ability Opto-Electronics TechnologyLtd. The image below shows that Ability Opto-Electronics TechnologyLtd has a significantly higher P/E than the average (12.7) P/E for companies in the electronic industry.
Ability Opto-Electronics TechnologyLtd’s P/E tells us that market participants think the company will perform better than its industry peers, going forward. 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. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
Ability Opto-Electronics TechnologyLtd’s earnings per share fell by 67% in the last twelve months. And EPS is down 10% a year, over the last 5 years. This might lead to muted expectations.
Remember: P/E Ratios Don’t Consider The Balance Sheet
It’s important to note that the P/E ratio considers the market capitalization, not the enterprise value. In other words, it does not consider any debt or cash that the company may have on the balance sheet. 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).
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).
Ability Opto-Electronics TechnologyLtd’s Balance Sheet
The extra options and safety that comes with Ability Opto-Electronics TechnologyLtd’s NT$130m net cash position means that it deserves a higher P/E than it would if it had a lot of net debt.
The Verdict On Ability Opto-Electronics TechnologyLtd’s P/E Ratio
Ability Opto-Electronics TechnologyLtd trades on a P/E ratio of 43.2, which is multiples above its market average of 13.6. 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 can be absolutely certain is that the market has become significantly less optimistic about Ability Opto-Electronics TechnologyLtd over the last month, with the P/E ratio falling from 62.4 back then to 43.2 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 the reality for a company is better than it expects, you can make money by buying and holding for the long term. We don’t have analyst forecasts, but shareholders might want to examine this detailed historical graph of earnings, revenue and cash flow.
You might be able to find a better buy than Ability Opto-Electronics TechnologyLtd. 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 email@example.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.
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