Xiabuxiabu Catering Management (China) Holdings (HKG:520) shareholders are no doubt pleased to see that the share price has had a great month, posting a 33% gain, recovering from prior weakness. But shareholders may not all be feeling jubilant, since the share price is still down 25% in the last year.

Assuming no other changes, a sharply higher share price makes a stock less 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. 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 Xiabuxiabu Catering Management (China) Holdings

Does Xiabuxiabu Catering Management (China) Holdings Have A Relatively High Or Low P/E For Its Industry?

Xiabuxiabu Catering Management (China) Holdings's P/E of 30.81 indicates some degree of optimism towards the stock. The image below shows that Xiabuxiabu Catering Management (China) Holdings has a higher P/E than the average (15.6) P/E for companies in the hospitality industry.

Its relatively high P/E ratio indicates that Xiabuxiabu Catering Management (China) Holdings shareholders think it will perform better than other companies in its industry classification. 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

If earnings fall then in the future the 'E' will be lower. That means unless the share price falls, the P/E will increase in a few years. Then, a higher P/E might scare off shareholders, pushing the share price down.

Xiabuxiabu Catering Management (China) Holdings saw earnings per share decrease by 38% last year. But over the longer term (5 years) earnings per share have increased by 9.9%. And EPS is down 8.0% a year, over the last 3 years. This could justify a low P/E.

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. In other words, it does not consider any debt or cash that the company may have on the balance sheet. 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).

Is Debt Impacting Xiabuxiabu Catering Management (China) Holdings's P/E?

Since Xiabuxiabu Catering Management (China) Holdings holds net cash of CN¥856m, it can spend on growth, justifying a higher P/E ratio than otherwise.

The Bottom Line On Xiabuxiabu Catering Management (China) Holdings's P/E Ratio

Xiabuxiabu Catering Management (China) Holdings trades on a P/E ratio of 30.8, which is multiples above its market average of 9.7. The recent drop in earnings per share would make some investors cautious, 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 Xiabuxiabu Catering Management (China) Holdings recently, since they have pushed its P/E ratio from 23.3 to 30.8 over the last month. For those who prefer to invest with the flow of momentum, that might mean it's time to put the stock on a watchlist, or research it. But the contrarian may see it as a missed opportunity.

Investors should be looking to buy stocks that the market is wrong about. People often underestimate remarkable growth -- so investors can make money when fast growth is not fully appreciated. So this free report on the analyst consensus forecasts could help you make a master move on this stock.

But note: Xiabuxiabu Catering Management (China) Holdings 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).

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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. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned. Thank you for reading.