This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We'll show how you can use Perfect Group International Holdings Limited's (HKG:3326) P/E ratio to inform your assessment of the investment opportunity. Looking at earnings over the last twelve months, Perfect Group International Holdings has a P/E ratio of 10.08. That corresponds to an earnings yield of approximately 9.9%.
How Do I Calculate A Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Perfect Group International Holdings:
P/E of 10.08 = HK$0.63 ÷ HK$0.06 (Based on the trailing twelve months to June 2019.)
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. 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.
Does Perfect Group International Holdings Have A Relatively High Or Low P/E For Its Industry?
The P/E ratio essentially measures market expectations of a company. The image below shows that Perfect Group International Holdings has a higher P/E than the average (9.0) P/E for companies in the luxury industry.
Perfect Group International Holdings's P/E tells us that market participants think the company will perform better than its industry peers, going forward. The market is optimistic about the future, but that doesn't guarantee future growth. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.
How Growth Rates Impact P/E Ratios
Earnings growth rates have a big influence on P/E ratios. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. 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.
Perfect Group International Holdings's 117% EPS improvement over the last year was like bamboo growth after rain; rapid and impressive. Even better, EPS is up 22% per year over three years. So you might say it really deserves to have an above-average P/E ratio.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. In other words, it does not consider any debt or cash that the company may have on the balance sheet. 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).
While growth expenditure doesn't always pay off, the point is that it is a good option to have; but one that the P/E ratio ignores.
So What Does Perfect Group International Holdings's Balance Sheet Tell Us?
With net cash of HK$241m, Perfect Group International Holdings has a very strong balance sheet, which may be important for its business. Having said that, at 29% of its market capitalization the cash hoard would contribute towards a higher P/E ratio.
The Bottom Line On Perfect Group International Holdings's P/E Ratio
Perfect Group International Holdings's P/E is 10.1 which is about average (10.1) in the HK market. The excess cash it carries is the gravy on top its fast EPS growth. So based on this analysis we'd expect Perfect Group International Holdings to have a higher P/E ratio.
When the market is wrong about a stock, it gives savvy investors an opportunity. As value investor Benjamin Graham famously said, 'In the short run, the market is a voting machine but in the long run, it is a weighing machine. We don't have analyst forecasts, but shareholders might want to examine this detailed historical graph of earnings, revenue and cash flow.
Of course you might be able to find a better stock than Perfect Group International Holdings. 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.
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. Thank you for reading.