This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We'll look at WH Group Limited's (HKG:288) P/E ratio and reflect on what it tells us about the company's share price. WH Group has a price to earnings ratio of 15.56, based on the last twelve months. That is equivalent to an earnings yield of about 6.4%.
How Do You Calculate WH Group's P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share (in the reporting currency) ÷ Earnings per Share (EPS)
Or for WH Group:
P/E of 15.56 = HK$1.06 (Note: this is the share price in the reporting currency, namely, USD ) ÷ HK$0.07 (Based on the year to June 2019.)
Is A High P/E Ratio Good?
A higher P/E ratio means that investors are paying a higher price for each HK$1 of company earnings. 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.
How Does WH 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. The image below shows that WH Group has a P/E ratio that is roughly in line with the food industry average (16.1).
WH Group's P/E tells us that market participants think its prospects are roughly in line with its industry. If the company has better than average prospects, then the market might be underestimating it. I would further inform my view by checking insider buying and selling., among other things.
How Growth Rates Impact P/E Ratios
Companies that shrink earnings per share quickly will rapidly decrease the 'E' in the equation. That means even if the current P/E is low, it will increase over time if the share price stays flat. Then, a higher P/E might scare off shareholders, pushing the share price down.
WH Group shrunk earnings per share by 6.2% last year. But EPS is up 52% over the last 5 years. And it has shrunk its earnings per share by 3.5% per year over the last three years. This growth rate might warrant a low P/E ratio. So it would be surprising to see a high P/E.
Remember: P/E Ratios Don't Consider The Balance Sheet
Don't forget that the P/E ratio considers market capitalization. Thus, the metric does not reflect cash or debt held by the company. 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 WH Group's Balance Sheet Tell Us?
WH Group's net debt is 19% of its market cap. That's enough debt to impact the P/E ratio a little; so keep it in mind if you're comparing it to companies without debt.
The Verdict On WH Group's P/E Ratio
WH Group has a P/E of 15.6. That's higher than the average in its market, which is 10.1. With some debt but no EPS growth last year, the market has high expectations of future profits.
Investors have an opportunity when market expectations about a stock are wrong. People often underestimate remarkable growth -- so investors can make money when fast growth is not fully appreciated. 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 WH Group. So you may wish to see this free collection of other companies that have grown earnings strongly.
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.
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