This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We'll show how you can use Haidilao International Holding Ltd.'s (HKG:6862) P/E ratio to inform your assessment of the investment opportunity. Haidilao International Holding has a price to earnings ratio of 79.09, based on the last twelve months. That corresponds to an earnings yield of approximately 1.3%.
How Do I Calculate Haidilao International Holding's Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share (in the reporting currency) ÷ Earnings per Share (EPS)
Or for Haidilao International Holding:
P/E of 79.09 = HK$29.06 (Note: this is the share price in the reporting currency, namely, CNY ) ÷ HK$0.37 (Based on the trailing twelve months to June 2019.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio means that buyers have to pay a higher price for each HK$1 the company has earned over the last year. That is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.
Does Haidilao International Holding 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 (12.5) for companies in the hospitality industry is a lot lower than Haidilao International Holding's P/E.
Haidilao International Holding's P/E tells us that market participants think the company will perform better than its industry peers, going forward. Shareholders are clearly optimistic, but the future is always uncertain. 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
Earnings growth rates have a big influence on P/E ratios. When earnings grow, the 'E' increases, over time. And in that case, the P/E ratio itself will drop rather quickly. Then, a lower P/E should attract more buyers, pushing the share price up.
Haidilao International Holding increased earnings per share by a whopping 43% last year. And it has bolstered its earnings per share by 44% per year over the last five years. I'd therefore be a little surprised if its P/E ratio was not relatively high.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
Don't forget that the P/E ratio considers market capitalization. That means it doesn't take debt or cash into account. 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.
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.
How Does Haidilao International Holding's Debt Impact Its P/E Ratio?
Haidilao International Holding has net cash of CN¥4.3b. That should lead to a higher P/E than if it did have debt, because its strong balance sheets gives it more options.
The Verdict On Haidilao International Holding's P/E Ratio
Haidilao International Holding's P/E is 79.1 which suggests the market is more focussed on the future opportunity rather than the current level of earnings. The excess cash it carries is the gravy on top its fast EPS growth. So based on this analysis we'd expect Haidilao International Holding to have a high P/E ratio.
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But note: Haidilao International Holding may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
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.
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