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 AAC Technologies Holdings Inc.'s (HKG:2018) P/E ratio to inform your assessment of the investment opportunity. AAC Technologies Holdings has a P/E ratio of 14.84, based on the last twelve months. That means that at current prices, buyers pay HK$14.84 for every HK$1 in trailing yearly profits.
How Do I Calculate AAC Technologies Holdings'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 AAC Technologies Holdings:
P/E of 14.84 = CN¥46.12 (Note: this is the share price in the reporting currency, namely, CNY ) ÷ CN¥3.11 (Based on the year to December 2018.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio means that investors are paying a higher price for each HK$1 of company earnings. 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. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. 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.
AAC Technologies Holdings's earnings per share fell by 29% in the last twelve months. But EPS is up 8.2% over the last 5 years.
Does AAC Technologies Holdings Have A Relatively High Or Low P/E For Its Industry?
One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. You can see in the image below that the average P/E (11.8) for companies in the electronic industry is lower than AAC Technologies Holdings's P/E.
AAC Technologies Holdings's P/E tells us that market participants think the company will perform better than its industry peers, going forward. Clearly the market expects growth, but it isn't guaranteed. So investors should delve deeper. I like to check if company insiders have been buying or selling.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. So it won't reflect the advantage of cash, or disadvantage of debt. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
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).
Is Debt Impacting AAC Technologies Holdings's P/E?
Net debt totals just 3.2% of AAC Technologies Holdings's market cap. So it doesn't have as many options as it would with net cash, but its debt would not have much of an impact on its P/E ratio.
The Verdict On AAC Technologies Holdings's P/E Ratio
AAC Technologies Holdings trades on a P/E ratio of 14.8, which is above the HK market average of 12. With some debt but no EPS growth last year, the market has high expectations of future profits.
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 visual report on analyst forecasts could hold the key to an excellent investment decision.
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.
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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. Thank you for reading.