The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We’ll look at Micro-Mechanics (Holdings) Ltd’s (SGX:5DD) P/E ratio and reflect on what it tells us about the company’s share price. Micro-Mechanics (Holdings) has a price to earnings ratio of 13.5, based on the last twelve months. That is equivalent to an earnings yield of about 7.4%.
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 Micro-Mechanics (Holdings):
P/E of 13.5 = SGD1.6 ÷ SGD0.12 (Based on the trailing twelve months to September 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
P/E ratios primarily reflect market expectations around earnings growth rates. When earnings grow, the ‘E’ increases, over time. That means unless the share price increases, the P/E will reduce in a few years. Then, a lower P/E should attract more buyers, pushing the share price up.
Micro-Mechanics (Holdings) maintained roughly steady earnings over the last twelve months. But it has grown its earnings per share by 18% per year over the last five years.
How Does Micro-Mechanics (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 (7.2) for companies in the semiconductor industry is lower than Micro-Mechanics (Holdings)’s P/E.
Its relatively high P/E ratio indicates that Micro-Mechanics (Holdings) shareholders think it will perform better than other companies in its industry classification. 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.
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. 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).
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 Micro-Mechanics (Holdings)’s Debt Impact Its P/E Ratio?
The extra options and safety that comes with Micro-Mechanics (Holdings)’s S$22m net cash position means that it deserves a higher P/E than it would if it had a lot of net debt.
The Bottom Line On Micro-Mechanics (Holdings)’s P/E Ratio
Micro-Mechanics (Holdings)’s P/E is 13.5 which is above average (12) in the SG market. The recent drop in earnings per share would make some investors cautious, but the net cash position means the company has time to improve: and the high P/E suggests the market thinks it will.
When the market is wrong about a stock, it gives savvy investors an opportunity. People often underestimate remarkable growth — so investors can make money when fast growth is not fully appreciated. So this free report on the analyst consensus forecasts could help you make a master move on this stock.
Of course you might be able to find a better stock than Micro-Mechanics (Holdings). So you may wish to see this free collection of other companies that have grown earnings strongly.
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.