Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll show how you can use Redco Properties Group Limited's (HKG:1622) P/E ratio to inform your assessment of the investment opportunity. Redco Properties Group has a price to earnings ratio of 12.17, based on the last twelve months. That means that at current prices, buyers pay HK$12.17 for every HK$1 in trailing yearly profits.
How Do You Calculate Redco Properties Group's 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 Redco Properties Group:
P/E of 12.17 = HK$3.56 (Note: this is the share price in the reporting currency, namely, CNY ) ÷ HK$0.29 (Based on the trailing twelve months to June 2019.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio implies that investors pay a higher price for the earning power of the business. That isn't a good or a bad thing on its own, but a high P/E means that buyers have a higher opinion of the business's prospects, relative to stocks with a lower P/E.
Does Redco Properties Group Have A Relatively High Or Low P/E For Its Industry?
The P/E ratio essentially measures market expectations of a company. As you can see below, Redco Properties Group has a higher P/E than the average company (6.0) in the real estate industry.
Redco Properties Group'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 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
P/E ratios primarily reflect market expectations around earnings growth rates. When earnings grow, the 'E' increases, over time. 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.
Redco Properties Group increased earnings per share by 6.8% last year. And its annual EPS growth rate over 5 years is 24%.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. So it won't reflect the advantage of cash, or disadvantage of debt. The exact same company would hypothetically deserve a higher P/E ratio if it had a strong balance sheet, than if it had a weak one with lots of debt, because a cashed up company can spend on growth.
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.
So What Does Redco Properties Group's Balance Sheet Tell Us?
Net debt is 44% of Redco Properties Group's market cap. While that's enough to warrant consideration, it doesn't really concern us.
The Verdict On Redco Properties Group's P/E Ratio
Redco Properties Group trades on a P/E ratio of 12.2, which is above its market average of 10.2. Given the debt is only modest, and earnings are already moving in the right direction, it's not surprising that the market expects continued improvement.
Investors should be looking to buy stocks that the market is wrong about. People often underestimate remarkable growth -- so investors can make money when fast growth is not fully appreciated. 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 Redco Properties Group. 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).
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.