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Despite Its High P/E Ratio, Is Kingdee International Software Group Company Limited (HKG:268) Still Undervalued?

Simply Wall St

Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. To keep it practical, we'll show how Kingdee International Software Group Company Limited's (HKG:268) P/E ratio could help you assess the value on offer. What is Kingdee International Software Group's P/E ratio? Well, based on the last twelve months it is 50.04. That is equivalent to an earnings yield of about 2.0%.

See our latest analysis for Kingdee International Software Group

How Do You Calculate Kingdee International Software Group's P/E Ratio?

The formula for price to earnings is:

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

Or for Kingdee International Software Group:

P/E of 50.04 = CN¥6.6 (Note: this is the share price in the reporting currency, namely, CNY ) ÷ CN¥0.13 (Based on the trailing twelve months to December 2018.)

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 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.

Does Kingdee International Software Group Have A Relatively High Or Low P/E For Its Industry?

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 (11.3) for companies in the software industry is a lot lower than Kingdee International Software Group's P/E.

SEHK:268 Price Estimation Relative to Market, August 8th 2019

That means that the market expects Kingdee International Software Group will outperform other companies in its industry. 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

Probably the most important factor in determining what P/E a company trades on is the earnings growth. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. That means even if the current P/E is high, it will reduce over time if the share price stays flat. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.

Kingdee International Software Group increased earnings per share by an impressive 19% over the last twelve months. And earnings per share have improved by 21% annually, over the last five years. This could arguably justify a relatively high P/E ratio.

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

One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. 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.

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).

Is Debt Impacting Kingdee International Software Group's P/E?

Since Kingdee International Software Group holds net cash of CN¥1.7b, it can spend on growth, justifying a higher P/E ratio than otherwise.

The Verdict On Kingdee International Software Group's P/E Ratio

With a P/E ratio of 50, Kingdee International Software Group is expected to grow earnings very strongly in the years to come. With cash in the bank the company has plenty of growth options -- and it is already on the right track. 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. 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.' So this free report on the analyst consensus forecasts could help you make a master move on this stock.

You might be able to find a better buy than Kingdee International Software Group. 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).

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.