This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). To keep it practical, we'll show how Magnificent Hotel Investments Limited's (HKG:201) P/E ratio could help you assess the value on offer. Magnificent Hotel Investments has a price to earnings ratio of 5.67, based on the last twelve months. That is equivalent to an earnings yield of about 18%.
How Do You Calculate A P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Magnificent Hotel Investments:
P/E of 5.67 = HK$0.17 ÷ HK$0.029 (Based on the year to December 2018.)
Is A High P/E 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 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 Magnificent Hotel Investments Have A Relatively High Or Low P/E For Its Industry?
One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. We can see in the image below that the average P/E (12.4) for companies in the hospitality industry is higher than Magnificent Hotel Investments's P/E.
Its relatively low P/E ratio indicates that Magnificent Hotel Investments shareholders think it will struggle to do as well as other companies in its industry classification. Since the market seems unimpressed with Magnificent Hotel Investments, it's quite possible it could surprise on the upside. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.
How Growth Rates Impact P/E Ratios
Generally speaking the rate of earnings growth has a profound impact on a company's P/E multiple. 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.
Magnificent Hotel Investments's 71% EPS improvement over the last year was like bamboo growth after rain; rapid and impressive. And earnings per share have improved by 40% annually, over the last three years. So we'd absolutely expect it to have a relatively high P/E ratio. Regrettably, the longer term performance is poor, with EPS down 16% per year over 5 years.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
The 'Price' in P/E reflects the market capitalization of the company. That means it doesn't take debt or cash into account. 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.
How Does Magnificent Hotel Investments's Debt Impact Its P/E Ratio?
Magnificent Hotel Investments has net cash of HK$48m. That should lead to a higher P/E than if it did have debt, because its strong balance sheets gives it more options.
The Verdict On Magnificent Hotel Investments's P/E Ratio
Magnificent Hotel Investments trades on a P/E ratio of 5.7, which is below the HK market average of 9.6. It grew its EPS nicely over the last year, and the healthy balance sheet implies there is more potential for growth. The below average P/E ratio suggests that market participants don't believe the strong growth will continue.
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. We don't have analyst forecasts, but you might want to assess this data-rich visualization of earnings, revenue and cash flow.
But note: Magnificent Hotel Investments 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).
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 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.