U.S. Markets open in 7 hrs 11 mins

Is Aoyuan Healthy Life Group Company Limited's (HKG:3662) High P/E Ratio A Problem For Investors?

Simply Wall St

This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We'll look at Aoyuan Healthy Life Group Company Limited's (HKG:3662) P/E ratio and reflect on what it tells us about the company's share price. Aoyuan Healthy Life Group has a price to earnings ratio of 20.96, based on the last twelve months. That is equivalent to an earnings yield of about 4.8%.

Check out our latest analysis for Aoyuan Healthy Life Group

How Do I Calculate A Price To Earnings Ratio?

The formula for P/E is:

Price to Earnings Ratio = Share Price (in reporting currency) ÷ Earnings per Share (EPS)

Or for Aoyuan Healthy Life Group:

P/E of 20.96 = HK$4.76 (Note: this is the share price in the reporting currency, namely, CNY ) ÷ HK$0.23 (Based on the trailing twelve months to June 2019.)

Is A High Price-to-Earnings Ratio Good?

A higher P/E ratio means that investors are paying a higher price for each HK$1 of company earnings. That is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.

How Does Aoyuan Healthy Life Group's P/E Ratio Compare To Its Peers?

We can get an indication of market expectations by looking at the P/E ratio. You can see in the image below that the average P/E (6.1) for companies in the real estate industry is a lot lower than Aoyuan Healthy Life Group's P/E.

SEHK:3662 Price Estimation Relative to Market, October 15th 2019

Its relatively high P/E ratio indicates that Aoyuan Healthy Life Group shareholders think it will perform better than other companies in its industry classification. The market is optimistic about the future, but that doesn't guarantee future growth. So further research is always essential. I often monitor director buying and selling.

How Growth Rates Impact P/E Ratios

P/E ratios primarily reflect market expectations around earnings growth rates. Earnings growth means that in the future the 'E' will be higher. 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.

Aoyuan Healthy Life Group increased earnings per share by a whopping 39% last year. And its annual EPS growth rate over 5 years is 27%. With that performance, I would expect it to have an above average P/E ratio.

A Limitation: P/E Ratios Ignore Debt and Cash In The Bank

It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. That means it doesn't take debt or cash into account. 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.

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.

So What Does Aoyuan Healthy Life Group's Balance Sheet Tell Us?

Aoyuan Healthy Life Group has net cash of CN¥995m. This is fairly high at 28% 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 Aoyuan Healthy Life Group's P/E Ratio

Aoyuan Healthy Life Group has a P/E of 21.0. That's higher than the average in its market, which is 10.4. The excess cash it carries is the gravy on top its fast EPS growth. So based on this analysis we'd expect Aoyuan Healthy Life Group to have a high P/E ratio.

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 visual report on analyst forecasts could hold the key to an excellent investment decision.

Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.

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.