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This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). To keep it practical, we’ll show how Huazhang Technology Holding Limited’s (HKG:1673) P/E ratio could help you assess the value on offer. Based on the last twelve months, Huazhang Technology Holding’s P/E ratio is 53.55. That corresponds to an earnings yield of approximately 1.9%.
How Do I Calculate A Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Share Price (in reporting currency) ÷ Earnings per Share (EPS)
Or for Huazhang Technology Holding:
P/E of 53.55 = CN¥3.84 (Note: this is the share price in the reporting currency, namely, CNY ) ÷ CN¥0.072 (Based on the year to June 2018.)
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 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.
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. Earnings growth means that in the future the ‘E’ will be higher. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. A lower P/E should indicate the stock is cheap relative to others — and that may attract buyers.
Huazhang Technology Holding increased earnings per share by a whopping 41% last year. And its annual EPS growth rate over 5 years is 10%. I’d therefore be a little surprised if its P/E ratio was not relatively high.
How Does Huazhang Technology Holding’s P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. As you can see below, Huazhang Technology Holding has a much higher P/E than the average company (10) in the machinery industry.
That means that the market expects Huazhang Technology Holding will outperform other companies in its industry. The market is optimistic about the future, but that doesn’t guarantee future growth. So investors should delve deeper. I like to check if company insiders have been buying or selling.
Remember: P/E Ratios Don’t Consider The Balance Sheet
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. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
Such spending might be good or bad, overall, but the key point here is that you need to look at debt to understand the P/E ratio in context.
Huazhang Technology Holding’s Balance Sheet
Net debt totals just 0.9% of Huazhang Technology Holding’s market cap. It would probably trade on a higher P/E ratio if it had a lot of cash, but I doubt it is having a big impact.
The Bottom Line On Huazhang Technology Holding’s P/E Ratio
Huazhang Technology Holding has a P/E of 53.6. That’s significantly higher than the average in the HK market, which is 10.6. Its debt levels do not imperil its balance sheet 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. Although we don’t have analyst forecasts, you might want to assess this data-rich visualization of earnings, revenue and cash flow.
You might be able to find a better buy than Huazhang Technology Holding. 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).
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 email@example.com.