The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We’ll look at Sinosoft Technology Group Limited’s (HKG:1297) P/E ratio and reflect on what it tells us about the company’s share price. Sinosoft Technology Group has a price to earnings ratio of 9.37, based on the last twelve months. That corresponds to an earnings yield of approximately 11%.
How Do You Calculate A P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price (in reporting currency) ÷ Earnings per Share (EPS)
Or for Sinosoft Technology Group:
P/E of 9.37 = CN¥1.84 (Note: this is the share price in the reporting currency, namely, CNY ) ÷ CN¥0.20 (Based on the trailing twelve months to June 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. 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 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 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.
Most would be impressed by Sinosoft Technology Group earnings growth of 22% in the last year. And its annual EPS growth rate over 5 years is 15%. With that performance, you might expect an above average P/E ratio.
How Does Sinosoft Technology Group’s P/E Ratio Compare To Its Peers?
The P/E ratio indicates whether the market has higher or lower expectations of a company. We can see in the image below that the average P/E (14.7) for companies in the software industry is higher than Sinosoft Technology Group’s P/E.
Sinosoft Technology Group’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. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and selling.
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. In theory, a company can lower its future P/E ratio by using cash or debt to invest in 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.
Is Debt Impacting Sinosoft Technology Group’s P/E?
The extra options and safety that comes with Sinosoft Technology Group’s CN¥130m net cash position means that it deserves a higher P/E than it would if it had a lot of net debt.
The Verdict On Sinosoft Technology Group’s P/E Ratio
Sinosoft Technology Group trades on a P/E ratio of 9.4, which is below the HK market average of 10.7. It grew its EPS nicely over the last year, and the healthy balance sheet implies there is more potential for growth. The relatively low P/E ratio implies the market is pessimistic. Given analysts are expecting further growth, one I would have expected a higher P/E ratio. So this stock may well be worth further research.
When the market is wrong about a stock, it gives savvy investors an opportunity. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. So this free visual report on analyst forecasts could hold they 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.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at email@example.com.