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Orient Paper & Industries (NSE:ORIENTPPR) shareholders are no doubt pleased to see that the share price has had a great month, posting a 39% gain, recovering from prior weakness. But shareholders may not all be feeling jubilant, since the share price is still down 34% in the last year.
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). 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). Investors have optimistic expectations of companies with higher P/E ratios, compared to companies with lower P/E ratios.
See our latest analysis for Orient Paper & Industries
Does Orient Paper & Industries Have A Relatively High Or Low P/E For Its Industry?
Orient Paper & Industries's P/E of 7.15 indicates relatively low sentiment towards the stock. We can see in the image below that the average P/E (9.2) for companies in the forestry industry is higher than Orient Paper & Industries's P/E.
This suggests that market participants think Orient Paper & Industries will underperform other companies in its industry. Many investors like to buy stocks when the market is pessimistic about their prospects. You should delve deeper. I like to check if company insiders have been buying or 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. And in that case, the P/E ratio itself will drop rather quickly. Then, a lower P/E should attract more buyers, pushing the share price up.
Orient Paper & Industries's 53% EPS improvement over the last year was like bamboo growth after rain; rapid and impressive. Even better, EPS is up 55% per year over three years. So we'd absolutely expect it to have a relatively high P/E ratio.
Remember: P/E Ratios Don't Consider The Balance Sheet
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. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.