This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We'll show how you can use Huazhong In-Vehicle Holdings Company Limited's (HKG:6830) P/E ratio to inform your assessment of the investment opportunity. Based on the last twelve months, Huazhong In-Vehicle Holdings's P/E ratio is 14.34. That means that at current prices, buyers pay HK$14.34 for every HK$1 in trailing yearly profits.
How Do I Calculate A Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share (in the reporting currency) ÷ Earnings per Share (EPS)
Or for Huazhong In-Vehicle Holdings:
P/E of 14.34 = HK$0.97 (Note: this is the share price in the reporting currency, namely, CNY ) ÷ HK$0.07 (Based on the year to June 2019.)
Is A High Price-to-Earnings Ratio Good?
The higher the P/E ratio, the higher the price tag of a business, relative to its trailing earnings. That isn't a good or a bad thing on its own, but a high P/E means that buyers have a higher opinion of the business's prospects, relative to stocks with a lower P/E.
How Does Huazhong In-Vehicle Holdings'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 (9.5) for companies in the auto components industry is lower than Huazhong In-Vehicle Holdings's P/E.
That means that the market expects Huazhong In-Vehicle Holdings will outperform other companies in its industry. Clearly the market expects growth, but it isn't guaranteed. 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. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.
Huazhong In-Vehicle Holdings shrunk earnings per share by 21% over the last year. But it has grown its earnings per share by 14% per year over the last five years.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
The 'Price' in P/E reflects the market capitalization of the company. In other words, it does not consider any debt or cash that the company may have on the balance sheet. 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.
How Does Huazhong In-Vehicle Holdings's Debt Impact Its P/E Ratio?
Huazhong In-Vehicle Holdings's net debt equates to 45% of its market capitalization. You'd want to be aware of this fact, but it doesn't bother us.
The Verdict On Huazhong In-Vehicle Holdings's P/E Ratio
Huazhong In-Vehicle Holdings's P/E is 14.3 which is above average (10.1) in its market. With some debt but no EPS growth last year, the market has high expectations of future profits.
Investors should be looking to buy stocks that the market is wrong about. As value investor Benjamin Graham famously said, 'In the short run, the market is a voting machine but in the long run, it is a weighing machine. Although we don't have analyst forecasts you could get a better understanding of its growth by checking out this more detailed historical graph of earnings, revenue and cash flow.
You might be able to find a better buy than Huazhong In-Vehicle Holdings. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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.
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. Thank you for reading.