The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We'll show how you can use Tai Sin Electric Limited's (SGX:500) P/E ratio to inform your assessment of the investment opportunity. Tai Sin Electric has a price to earnings ratio of 11.21, based on the last twelve months. In other words, at today's prices, investors are paying SGD11.21 for every SGD1 in prior year profit.
How Do You Calculate A P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Tai Sin Electric:
P/E of 11.21 = SGD0.33 ÷ SGD0.03 (Based on the year to September 2019.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio means that investors are paying a higher price for each SGD1 of company earnings. 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 Tai Sin Electric 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 Tai Sin Electric has a lower P/E than the average (18.0) in the electrical industry classification.
Its relatively low P/E ratio indicates that Tai Sin Electric shareholders think it will struggle to do as well as other companies in its industry classification. Since the market seems unimpressed with Tai Sin Electric, 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
When earnings fall, the 'E' decreases, over time. Therefore, even if you pay a low multiple of earnings now, that multiple will become higher in the future. Then, a higher P/E might scare off shareholders, pushing the share price down.
Tai Sin Electric shrunk earnings per share by 7.2% last year. And it has shrunk its earnings per share by 9.4% per year over the last five years. So it would be surprising to see a high P/E.
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. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
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).
Is Debt Impacting Tai Sin Electric's P/E?
Tai Sin Electric has net debt worth just 2.4% of its market capitalization. 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 Tai Sin Electric's P/E Ratio
Tai Sin Electric trades on a P/E ratio of 11.2, which is below the SG market average of 13.0. With only modest debt, it's likely the lack of EPS growth at least partially explains the pessimism implied by the P/E ratio.
Investors should be looking to buy stocks that the market is wrong about. As value investor Benjamin Graham famously said, 'In the short run, the market is a voting machine but in the long run, it is a weighing machine. Although we don't have analyst forecasts you might want to assess this data-rich visualization of earnings, revenue and cash flow.
Of course you might be able to find a better stock than Tai Sin Electric. So you may wish to see this free collection of other companies that have grown earnings strongly.
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.
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. Thank you for reading.