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Despite Its High P/E Ratio, Is Shanghai Kindly Medical Instruments Co., Ltd. (HKG:1501) Still Undervalued?

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 show how you can use Shanghai Kindly Medical Instruments Co., Ltd.'s (HKG:1501) P/E ratio to inform your assessment of the investment opportunity. Shanghai Kindly Medical Instruments has a P/E ratio of 42.56, based on the last twelve months. That is equivalent to an earnings yield of about 2.3%.

View our latest analysis for Shanghai Kindly Medical Instruments

How Do I Calculate A Price To Earnings Ratio?

The formula for P/E is:

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

Or for Shanghai Kindly Medical Instruments:

P/E of 42.56 = CN¥33.470 ÷ CN¥0.786 (Based on the trailing twelve months to December 2019.)

(Note: the above calculation uses the share price in the reporting currency, namely CNY and the calculation results may not be precise due to rounding.)

Is A High Price-to-Earnings Ratio Good?

A higher P/E ratio implies that investors pay a higher price for the earning power of the business. 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 Shanghai Kindly Medical Instruments's P/E Ratio Compare To Its Peers?

The P/E ratio indicates whether the market has higher or lower expectations of a company. You can see in the image below that the average P/E (33.8) for companies in the medical equipment industry is lower than Shanghai Kindly Medical Instruments's P/E.

SEHK:1501 Price Estimation Relative to Market March 26th 2020

Its relatively high P/E ratio indicates that Shanghai Kindly Medical Instruments 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 delve deeper. I like to check if company insiders have been buying or selling.

How Growth Rates Impact P/E Ratios

Earnings growth rates have a big influence on P/E ratios. Earnings growth means that in the future the 'E' will be higher. That means unless the share price increases, the P/E will reduce in a few years. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.

Most would be impressed by Shanghai Kindly Medical Instruments earnings growth of 16% in the last year. And it has bolstered its earnings per share by 14% per year over the last five years. So one might expect an above average P/E ratio.

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

The 'Price' in P/E reflects the market capitalization of the company. Thus, the metric does not reflect cash or debt held by the company. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.

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).

How Does Shanghai Kindly Medical Instruments's Debt Impact Its P/E Ratio?

Shanghai Kindly Medical Instruments has net cash of CN¥1.1b. This is fairly high at 19% 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 Shanghai Kindly Medical Instruments's P/E Ratio

Shanghai Kindly Medical Instruments has a P/E of 42.6. That's significantly higher than the average in its market, which is 8.5. Its strong balance sheet gives the company plenty of resources for extra growth, and it has already proven it can grow. So it does not seem strange that the P/E is above average.

When the market is wrong about a stock, it gives savvy investors an opportunity. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. 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.

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.

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.