The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). To keep it practical, we'll show how Fu Shou Yuan International Group Limited's (HKG:1448) P/E ratio could help you assess the value on offer. Fu Shou Yuan International Group has a price to earnings ratio of 26.36, based on the last twelve months. That means that at current prices, buyers pay HK$26.36 for every HK$1 in trailing yearly profits.
How Do I Calculate Fu Shou Yuan International Group'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 Fu Shou Yuan International Group:
P/E of 26.36 = CN¥5.86 (Note: this is the share price in the reporting currency, namely, CNY ) ÷ CN¥0.22 (Based on the year to December 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. 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 Does Fu Shou Yuan International Group's P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. The image below shows that Fu Shou Yuan International Group has a higher P/E than the average (16.8) P/E for companies in the consumer services industry.
Fu Shou Yuan International Group's P/E tells us that market participants think the company will perform better than its industry peers, going forward. 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.
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. That means even if the current P/E is high, it will reduce over time if the share price stays flat. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
It's great to see that Fu Shou Yuan International Group grew EPS by 14% in the last year. And earnings per share have improved by 15% annually, over the last five years. This could arguably justify a relatively high P/E ratio.
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 expenditure might be good or bad, in the long term, but the point here is that the balance sheet is not reflected by this ratio.
Is Debt Impacting Fu Shou Yuan International Group's P/E?
Fu Shou Yuan International Group has net cash of CN¥2.0b. This is fairly high at 15% of its market capitalization. That might mean balance sheet strength is important to the business, but should also help push the P/E a bit higher than it would otherwise be.
The Verdict On Fu Shou Yuan International Group's P/E Ratio
Fu Shou Yuan International Group's P/E is 26.4 which is above average (10.5) in its market. Its strong balance sheet gives the company plenty of resources for extra growth, and it has already proven it can grow. So it is not surprising the market is probably extrapolating recent growth well into the future, reflected in the relatively high P/E ratio.
Investors should be looking to buy stocks that the market is wrong about. 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 be able to find a better stock than Fu Shou Yuan International Group. So you may wish to see this free collection of other companies that have grown earnings strongly.
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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.