Somerley Capital Holdings (HKG:8439) shares have had a really impressive month, gaining 32%, after some slippage. Unfortunately, the full year gain of 9.5% wasn't so sweet.

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. So some would prefer to hold off buying when there is a lot of optimism towards a stock. 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.

Check out our latest analysis for Somerley Capital Holdings

Does Somerley Capital Holdings Have A Relatively High Or Low P/E For Its Industry?

We can tell from its P/E ratio of 37.89 that there is some investor optimism about Somerley Capital Holdings. The image below shows that Somerley Capital Holdings has a significantly higher P/E than the average (12.3) P/E for companies in the capital markets industry.

Its relatively high P/E ratio indicates that Somerley Capital Holdings shareholders think it will perform better than other companies in its industry classification. Shareholders are clearly optimistic, but the future is always uncertain. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.

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. That means unless the share price increases, the P/E will reduce in a few years. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.

Somerley Capital Holdings increased earnings per share by an impressive 25% over the last twelve months. And earnings per share have improved by 47% annually, over the last three years. This could arguably justify a relatively high P/E ratio.

Remember: P/E Ratios Don't Consider The Balance Sheet

Don't forget that the P/E ratio considers market capitalization. So it won't reflect the advantage of cash, or disadvantage of debt. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.

Such expenditure might be good or bad, in the long term, but the point here is that the balance sheet is not reflected by this ratio.

How Does Somerley Capital Holdings's Debt Impact Its P/E Ratio?

Somerley Capital Holdings has net cash of HK$102m. This is fairly high at 39% of its market capitalization. That might mean balance sheet strength is important to the business, but should also help push the P/E a bit higher than it would otherwise be.

The Verdict On Somerley Capital Holdings's P/E Ratio

Somerley Capital Holdings has a P/E of 37.9. That's significantly higher than the average in its market, which is 10.5. With cash in the bank the company has plenty of growth options -- and it is already on the right track. So it is not surprising the market is probably extrapolating recent growth well into the future, reflected in the relatively high P/E ratio. What is very clear is that the market has become significantly more optimistic about Somerley Capital Holdings over the last month, with the P/E ratio rising from 28.7 back then to 37.9 today. If you like to buy stocks that have recently impressed the market, then this one might be a candidate; but if you prefer to invest when there is 'blood in the streets', then you may feel the opportunity has passed.

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. We don't have analyst forecasts, but you might want to assess this data-rich visualization of earnings, revenue and cash flow.

Of course you might be able to find a better stock than Somerley Capital Holdings. So you may wish to see this free collection of other companies that have grown earnings strongly.

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.