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 Quanzhou Huixin Micro-Credit Co., Ltd.'s (HKG:1577) P/E ratio could help you assess the value on offer. What is Quanzhou Huixin Micro-Credit's P/E ratio? Well, based on the last twelve months it is 9.25. That means that at current prices, buyers pay HK$9.25 for every HK$1 in trailing yearly profits.
How Do I Calculate A Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share (in the reporting currency) ÷ Earnings per Share (EPS)
Or for Quanzhou Huixin Micro-Credit:
P/E of 9.25 = CNY1.17 (Note: this is the share price in the reporting currency, namely, CNY ) ÷ CNY0.13 (Based on the trailing twelve months to June 2019.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio means that buyers have to pay a higher price for each CNY1 the company has earned over the last year. That isn't necessarily good or bad, but a high P/E implies relatively high expectations of what a company can achieve in the future.
How Does Quanzhou Huixin Micro-Credit's P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. As you can see below, Quanzhou Huixin Micro-Credit has a higher P/E than the average company (6.4) in the consumer finance industry.
Quanzhou Huixin Micro-Credit's P/E tells us that market participants think the company will perform better than its industry peers, going forward. Clearly the market expects growth, but it isn't guaranteed. So investors should delve deeper. I like to check if company insiders have been buying or selling.
How Growth Rates Impact P/E Ratios
Companies that shrink earnings per share quickly will rapidly decrease the 'E' in the equation. That means unless the share price falls, the P/E will increase in a few years. A higher P/E should indicate the stock is expensive relative to others -- and that may encourage shareholders to sell.
Quanzhou Huixin Micro-Credit shrunk earnings per share by 7.4% last year. But EPS is up 1.3% over the last 5 years. And EPS is down 6.1% a year, over the last 3 years. So you wouldn't expect a very high P/E.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. 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.
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.
Quanzhou Huixin Micro-Credit's Balance Sheet
Quanzhou Huixin Micro-Credit's net debt is 4.6% of its market cap. It would probably trade on a higher P/E ratio if it had a lot of cash, but I doubt it is having a big impact.
The Bottom Line On Quanzhou Huixin Micro-Credit's P/E Ratio
Quanzhou Huixin Micro-Credit trades on a P/E ratio of 9.3, which is fairly close to the HK market average of 9.9. 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 should be looking to buy stocks that the market is wrong about. If the reality for a company is not as bad as the P/E ratio indicates, then the share price should increase as the market realizes this. 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 Quanzhou Huixin Micro-Credit. 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).
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.
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