This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We'll apply a basic P/E ratio analysis to Yue Yuen Industrial (Holdings) Limited's (HKG:551), to help you decide if the stock is worth further research. Looking at earnings over the last twelve months, Yue Yuen Industrial (Holdings) has a P/E ratio of 14.29. That corresponds to an earnings yield of approximately 7.0%.
How Do You Calculate Yue Yuen Industrial (Holdings)'s P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Share Price (in reporting currency) ÷ Earnings per Share (EPS)
Or for Yue Yuen Industrial (Holdings):
P/E of 14.29 = HK$2.85 (Note: this is the share price in the reporting currency, namely, USD ) ÷ HK$0.20 (Based on the trailing twelve months 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 necessarily good or bad, but a high P/E implies relatively high expectations of what a company can achieve in the future.
How Does Yue Yuen Industrial (Holdings)'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 (9.2) for companies in the luxury industry is lower than Yue Yuen Industrial (Holdings)'s P/E.
That means that the market expects Yue Yuen Industrial (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
If earnings fall then in the future the 'E' will be lower. That means even if the current P/E is low, it will increase over time if the share price stays flat. A higher P/E should indicate the stock is expensive relative to others -- and that may encourage shareholders to sell.
Yue Yuen Industrial (Holdings)'s earnings per share fell by 20% in the last twelve months. And over the longer term (3 years) earnings per share have decreased 8.5% annually. This could justify a low P/E.
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. So it won't reflect the advantage of cash, or disadvantage of debt. 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).
Yue Yuen Industrial (Holdings)'s Balance Sheet
Yue Yuen Industrial (Holdings)'s net debt equates to 27% of its market capitalization. While that's enough to warrant consideration, it doesn't really concern us.
The Verdict On Yue Yuen Industrial (Holdings)'s P/E Ratio
Yue Yuen Industrial (Holdings)'s P/E is 14.3 which is above average (10.4) in its market. With modest debt but no EPS growth in the last year, it's fair to say the P/E implies some optimism about future earnings, from the market.
Investors have an opportunity when market expectations about a stock are wrong. 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 visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.
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.
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 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. Thank you for reading.