The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). To keep it practical, we'll show how Lifestyle International Holdings Limited's (HKG:1212) P/E ratio could help you assess the value on offer. Based on the last twelve months, Lifestyle International Holdings's P/E ratio is 9.93. That is equivalent to an earnings yield of about 10%.
How Do I Calculate Lifestyle International Holdings's Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Lifestyle International Holdings:
P/E of 9.93 = HK$10.7 ÷ HK$1.08 (Based on the trailing twelve months to December 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 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 Lifestyle International Holdings'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 Lifestyle International Holdings has a P/E ratio that is roughly in line with the multiline retail industry average (10).
Lifestyle International Holdings's P/E tells us that market participants think its prospects are roughly in line with its industry. So if Lifestyle International Holdings actually outperforms its peers going forward, that should be a positive for the share price. Further research into factors such as insider buying and selling, could help you form your own view on whether that is likely.
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. And in that case, the P/E ratio itself will drop rather quickly. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
Lifestyle International Holdings's earnings per share fell by 40% in the last twelve months. But it has grown its earnings per share by 3.3% per year over the last three years. And over the longer term (5 years) earnings per share have decreased 6.1% annually. This could justify a pessimistic P/E.
Remember: P/E Ratios Don't Consider The Balance Sheet
Don't forget that the P/E ratio considers market capitalization. So it won't reflect the advantage of cash, or disadvantage of debt. Theoretically, a business can improve its earnings (and produce a lower P/E in the future) by investing in growth. That means taking on debt (or spending its cash).
Spending on growth might be good or bad a few years later, but the point is that the P/E ratio does not account for the option (or lack thereof).
How Does Lifestyle International Holdings's Debt Impact Its P/E Ratio?
Net debt is 41% of Lifestyle International Holdings's market cap. While that's enough to warrant consideration, it doesn't really concern us.
The Bottom Line On Lifestyle International Holdings's P/E Ratio
Lifestyle International Holdings has a P/E of 9.9. That's around the same as the average in the HK market, which is 10.5. Given it has some debt, but didn't grow last year, the P/E indicates the market is expecting higher profits ahead for the business.
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. So this free visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.
Of course you might be able to find a better stock than Lifestyle International Holdings. So you may wish to see this free collection of other companies that have grown earnings strongly.
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.