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Read This Before You Buy KWG Group Holdings Limited (HKG:1813) Because Of Its P/E Ratio

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Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll apply a basic P/E ratio analysis to KWG Group Holdings Limited's (HKG:1813), to help you decide if the stock is worth further research. KWG Group Holdings has a price to earnings ratio of 5.45, based on the last twelve months. In other words, at today's prices, investors are paying HK$5.45 for every HK$1 in prior year profit.

Check out our latest analysis for KWG Group Holdings

How Do You Calculate KWG Group Holdings's P/E Ratio?

The formula for P/E is:

Price to Earnings Ratio = Share Price (in reporting currency) ÷ Earnings per Share (EPS)

Or for KWG Group Holdings:

P/E of 5.45 = CN¥6.95 (Note: this is the share price in the reporting currency, namely, CNY ) ÷ CN¥1.28 (Based on the year to December 2018.)

Is A High Price-to-Earnings Ratio Good?

A higher P/E ratio means that buyers have to pay a higher price for each HK$1 the company has earned over the last year. 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 Growth Rates Impact P/E Ratios

P/E ratios primarily reflect market expectations around earnings growth rates. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. That means unless the share price increases, the P/E will reduce in a few years. And as that P/E ratio drops, the company will look cheap, unless its share price increases.

KWG Group Holdings saw earnings per share improve by -9.2% last year. And earnings per share have improved by 6.1% annually, over the last five years.

Does KWG Group Holdings Have A Relatively High Or Low P/E For Its Industry?

We can get an indication of market expectations by looking at the P/E ratio. We can see in the image below that the average P/E (6.3) for companies in the real estate industry is higher than KWG Group Holdings's P/E.

SEHK:1813 Price Estimation Relative to Market, May 30th 2019

This suggests that market participants think KWG Group Holdings will underperform other companies in its industry. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. You should delve deeper. I like to check if company insiders have been buying or selling.

Don't Forget: The P/E Does Not Account For Debt or Bank Deposits

One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. 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).

Such expenditure might be good or bad, in the long term, but the point here is that the balance sheet is not reflected by this ratio.

Is Debt Impacting KWG Group Holdings's P/E?

KWG Group Holdings has net debt worth 98% of its market capitalization. This is enough debt that you'd have to make some adjustments before using the P/E ratio to compare it to a company with net cash.

The Bottom Line On KWG Group Holdings's P/E Ratio

KWG Group Holdings has a P/E of 5.4. That's below the average in the HK market, which is 11.1. It's good to see EPS growth in the last 12 months, but the debt on the balance sheet might be muting expectations.

When the market is wrong about a stock, it gives savvy investors an opportunity. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. So this free report on the analyst consensus forecasts could help you make a master move on this stock.

Of course you might be able to find a better stock than KWG Group 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 editorial-team@simplywallst.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.