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This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). To keep it practical, we'll show how Wai Hung Group Holdings Limited's (HKG:3321) P/E ratio could help you assess the value on offer. Wai Hung Group Holdings has a P/E ratio of 11.52, based on the last twelve months. That means that at current prices, buyers pay HK$11.52 for every HK$1 in trailing yearly profits.
How Do You Calculate A P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Share Price (in reporting currency) ÷ Earnings per Share (EPS)
Or for Wai Hung Group Holdings:
P/E of 11.52 = MOP1.01 (Note: this is the share price in the reporting currency, namely, MOP ) ÷ MOP0.088 (Based on the trailing twelve months to December 2018.)
Is A High P/E Ratio Good?
The higher the P/E ratio, the higher the price tag of a business, relative to its trailing earnings. That is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.
Does Wai Hung Group 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. We can see in the image below that the average P/E (13.3) for companies in the commercial services industry is higher than Wai Hung Group Holdings's P/E.
This suggests that market participants think Wai Hung Group Holdings will underperform other companies in its 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.
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. 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. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.
Wai Hung Group Holdings increased earnings per share by an impressive 23% over the last twelve months. And it has bolstered its earnings per share by 12% per year over the last five years. So one might expect an above average P/E ratio.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
The 'Price' in P/E reflects the market capitalization of the company. That means it doesn't take debt or cash into account. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
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.
So What Does Wai Hung Group Holdings's Balance Sheet Tell Us?
Wai Hung Group Holdings has net cash of MO$8.6m. That should lead to a higher P/E than if it did have debt, because its strong balance sheets gives it more options.
The Verdict On Wai Hung Group Holdings's P/E Ratio
Wai Hung Group Holdings has a P/E of 11.5. That's around the same as the average in the HK market, which is 10.8. Considering its recent growth, alongside its lack of debt, it would appear that the market isn't very excited about the future.
When the market is wrong about a stock, it gives savvy investors an opportunity. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. Although we don't have analyst forecasts, 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 Wai Hung Group Holdings. 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).
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 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.