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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 AV Promotions Holdings Limited's (HKG:8419) P/E ratio to inform your assessment of the investment opportunity. AV Promotions Holdings has a price to earnings ratio of 5.58, based on the last twelve months. That means that at current prices, buyers pay HK$5.58 for every HK$1 in trailing yearly profits.
How Do I Calculate A Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for AV Promotions Holdings:
P/E of 5.58 = HK$0.32 ÷ HK$0.06 (Based on the year to September 2019.)
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 AV Promotions Holdings's P/E Ratio Compare To Its Peers?
We can get an indication of market expectations by looking at the P/E ratio. The image below shows that AV Promotions Holdings has a lower P/E than the average (12.2) P/E for companies in the commercial services industry.
AV Promotions Holdings's P/E tells us that market participants think it will not fare as well as its peers in the same industry. Many investors like to buy stocks when the market is pessimistic about their prospects. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.
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. That means even if the current P/E is high, it will reduce over time if the share price stays flat. Then, a lower P/E should attract more buyers, pushing the share price up.
In the last year, AV Promotions Holdings grew EPS like Taylor Swift grew her fan base back in 2010; the 122% gain was both fast and well deserved. And earnings per share have improved by 39% annually, over the last three years. So we'd absolutely expect it to have a relatively high 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. Theoretically, a business can improve its earnings (and produce a lower P/E in the future) by investing in growth. That means taking on debt (or spending its 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.
AV Promotions Holdings's Balance Sheet
AV Promotions Holdings's net debt equates to 41% of its market capitalization. While it's worth keeping this in mind, it isn't a worry.
The Verdict On AV Promotions Holdings's P/E Ratio
AV Promotions Holdings's P/E is 5.6 which is below average (10.2) in the HK market. The EPS growth last year was strong, and debt levels are quite reasonable. The low P/E ratio suggests current market expectations are muted, implying these levels of growth will not continue.
When the market is wrong about a stock, it gives savvy investors an opportunity. 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 might want to assess this data-rich visualization of earnings, revenue and cash flow.
Of course you might be able to find a better stock than AV Promotions Holdings. So you may wish to see this free collection of other companies that have grown earnings strongly.
If you spot an error that warrants correction, please contact the editor at email@example.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.