This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We’ll look at China HGS Real Estate Inc’s (NASDAQ:HGSH) P/E ratio and reflect on what it tells us about the company’s share price. Based on the last twelve months, China HGS Real Estate’s P/E ratio is 5.66. In other words, at today’s prices, investors are paying $5.66 for every $1 in prior year profit.
How Do You Calculate A P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for China HGS Real Estate:
P/E of 5.66 = $1.23 ÷ $0.22 (Based on the trailing twelve months to June 2018.)
Is A High P/E Ratio Good?
A higher P/E ratio implies that investors pay a higher price for the earning power of the business. All else being equal, it’s better to pay a low price — but as Warren Buffett said, ‘It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.’
How Growth Rates Impact P/E Ratios
Companies that shrink earnings per share quickly will rapidly decrease the ‘E’ in the equation. That means even if the current P/E is low, it will increase over time if the share price stays flat. Then, a higher P/E might scare off shareholders, pushing the share price down.
Notably, China HGS Real Estate grew EPS by a whopping 226% in the last year. In contrast, EPS has decreased by 27%, annually, over 5 years.
How Does China HGS Real Estate’s P/E Ratio Compare To Its Peers?
We can get an indication of market expectations by looking at the P/E ratio. If you look at the image below, you can see China HGS Real Estate has a lower P/E than the average (14.8) in the real estate industry classification.
China HGS Real Estate’s P/E tells us that market participants think it will not fare as well as its peers in the same industry. Since the market seems unimpressed with China HGS Real Estate, it’s quite possible it could surprise on the upside. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.
Don’t Forget: The P/E Does Not Account For Debt or Bank Deposits
Don’t forget that the P/E ratio considers market capitalization. That means it doesn’t take debt or cash into account. Theoretically, a business can improve its earnings (and produce a lower P/E in the future), by taking on debt (or spending its remaining cash).
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.
China HGS Real Estate’s Balance Sheet
China HGS Real Estate has net debt worth a very significant 225% of its market capitalization. This level of debt justifies a relatively low P/E, so remain cognizant of the debt, if you’re comparing it to other stocks.
The Verdict On China HGS Real Estate’s P/E Ratio
China HGS Real Estate’s P/E is 5.7 which is below average (18) in the US market. The company has a meaningful amount of debt on the balance sheet, but that should not eclipse the solid earnings growth. If the company can continue to grow earnings, then the current P/E may be unjustifiably low.
Investors should be looking to buy stocks that the market is wrong about. If the reality for a company is not as bad as the P/E ratio indicates, then the share price should increase as the market realizes this. We don’t have analyst forecasts, but you could get a better understanding of its growth by checking out this more detailed historical graph of earnings, revenue and cash flow.
But note: China HGS Real Estate 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).
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at firstname.lastname@example.org.