Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll look at Hang Lung Group Limited's (HKG:10) P/E ratio and reflect on what it tells us about the company's share price. Looking at earnings over the last twelve months, Hang Lung Group has a P/E ratio of 4.76. That corresponds to an earnings yield of approximately 21.0%.
How Do You Calculate Hang Lung Group's P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Hang Lung Group:
P/E of 4.76 = HKD20.80 ÷ HKD4.37 (Based on the year to June 2019.)
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. 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'.
Does Hang Lung Group 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. We can see in the image below that the average P/E (7.0) for companies in the real estate industry is higher than Hang Lung Group's P/E.
This suggests that market participants think Hang Lung Group will underperform other companies in its industry. Many investors like to buy stocks when the market is pessimistic about their prospects. You should delve deeper. I like to check if company insiders have been buying or selling.
How Growth Rates Impact P/E Ratios
Earnings growth rates have a big influence on P/E ratios. That's because companies that grow earnings per share quickly will rapidly increase the 'E' in the equation. That means unless the share price increases, the P/E will reduce in a few years. Then, a lower P/E should attract more buyers, pushing the share price up.
Hang Lung Group's earnings per share were pretty steady over the last year. But EPS is up 4.0% over the last 5 years.
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. In other words, it does not consider any debt or cash that the company may have on the balance sheet. 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.
So What Does Hang Lung Group's Balance Sheet Tell Us?
Net debt totals a substantial 105% of Hang Lung Group's market cap. This level of debt justifies a relatively low P/E, so remain cognizant of the debt, if you're comparing it to other stocks.
The Verdict On Hang Lung Group's P/E Ratio
Hang Lung Group has a P/E of 4.8. That's below the average in the HK market, which is 10.6. The meaningful debt load is probably contributing to low expectations, even though it has improved earnings recently.
Investors have an opportunity when market expectations about a stock are wrong. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. We don't have analyst forecasts, but 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 Hang Lung Group. 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).
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.
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. Thank you for reading.