The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We'll apply a basic P/E ratio analysis to K2 F&B Holdings Limited's (HKG:2108), to help you decide if the stock is worth further research. Looking at earnings over the last twelve months, K2 F&B Holdings has a P/E ratio of 5.28. That corresponds to an earnings yield of approximately 19%.
How Do I Calculate A Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share (in the reporting currency) ÷ Earnings per Share (EPS)
Or for K2 F&B Holdings:
P/E of 5.28 = SGD0.035 (Note: this is the share price in the reporting currency, namely, SGD ) ÷ SGD0.0067 (Based on the year to December 2018.)
Is A High P/E 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.
How Does K2 F&B Holdings's P/E Ratio Compare To Its Peers?
One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. We can see in the image below that the average P/E (14.3) for companies in the hospitality industry is higher than K2 F&B Holdings's P/E.
K2 F&B Holdings's P/E tells us that market participants think it will not fare as well as its peers in the same industry. Many investors like to buy stocks when the market is pessimistic about their prospects. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.
How Growth Rates Impact P/E Ratios
Generally speaking the rate of earnings growth has a profound impact on a company's P/E multiple. When earnings grow, the 'E' increases, over time. 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.
K2 F&B Holdings shrunk earnings per share by 27% over the last year.
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. 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.
K2 F&B Holdings's Balance Sheet
Net debt totals a substantial 166% of K2 F&B Holdings'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 Bottom Line On K2 F&B Holdings's P/E Ratio
K2 F&B Holdings has a P/E of 5.3. That's below the average in the HK market, which is 10.8. When you consider that the company has significant debt, and didn't grow EPS last year, it isn't surprising that the market has muted expectations.
Investors should be looking to buy stocks that the market is wrong about. 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 could get a better understanding of its growth by checking out this more detailed historical graph of earnings, revenue and cash flow.
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.
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.
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.