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 Jiayin Group Inc.'s (NASDAQ:JFIN) P/E ratio could help you assess the value on offer. Jiayin Group has a price to earnings ratio of 6.41, based on the last twelve months. That is equivalent to an earnings yield of about 16%.
How Do You Calculate A P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price (in reporting currency) ÷ Earnings per Share (EPS)
Or for Jiayin Group:
P/E of 6.41 = CN¥74.72 (Note: this is the share price in the reporting currency, namely, CNY ) ÷ CN¥11.66 (Based on the year to March 2019.)
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 isn't necessarily good or bad, but a high P/E implies relatively high expectations of what a company can achieve in the future.
Does Jiayin Group Have A Relatively High Or Low P/E For Its Industry?
The P/E ratio essentially measures market expectations of a company. If you look at the image below, you can see Jiayin Group has a lower P/E than the average (9.3) in the consumer finance industry classification.
This suggests that market participants think Jiayin Group will underperform other companies in its industry. Since the market seems unimpressed with Jiayin Group, it's quite possible it could surprise on the upside. You should delve deeper. I like to check if company insiders have been buying or selling.
How Growth Rates Impact P/E Ratios
P/E ratios primarily reflect market expectations around earnings growth rates. Earnings growth means that in the future the 'E' will be higher. That means even if the current P/E is high, it will reduce over time if the share price stays flat. And as that P/E ratio drops, the company will look cheap, unless its share price increases.
Jiayin Group saw earnings per share improve by -4.6% last year.
Remember: P/E Ratios Don't Consider The Balance Sheet
The 'Price' in P/E reflects the market capitalization of the company. So it won't reflect the advantage of cash, or disadvantage of debt. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.
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).
So What Does Jiayin Group's Balance Sheet Tell Us?
The extra options and safety that comes with Jiayin Group's CN¥85m net cash position means that it deserves a higher P/E than it would if it had a lot of net debt.
The Verdict On Jiayin Group's P/E Ratio
Jiayin Group trades on a P/E ratio of 6.4, which is below the US market average of 17.2. Earnings improved over the last year. And the healthy balance sheet means the company can sustain growth while the P/E suggests shareholders don't think it will.
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 could get a better understanding of its growth by checking out this more detailed historical graph of earnings, revenue and cash flow.
But note: Jiayin Group may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
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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.