Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. To keep it practical, we'll show how Fu Shou Yuan International Group Limited's (HKG:1448) P/E ratio could help you assess the value on offer. Fu Shou Yuan International Group has a P/E ratio of 25.99, based on the last twelve months. That is equivalent to an earnings yield of about 3.8%.
How Do You Calculate Fu Shou Yuan International Group's P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share (in the reporting currency) ÷ Earnings per Share (EPS)
Or for Fu Shou Yuan International Group:
P/E of 25.99 = HK$6.12 (Note: this is the share price in the reporting currency, namely, CNY ) ÷ HK$0.24 (Based on the trailing twelve months to June 2019.)
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 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 Fu Shou Yuan International Group Have A Relatively High Or Low P/E For Its Industry?
The P/E ratio indicates whether the market has higher or lower expectations of a company. You can see in the image below that the average P/E (15.2) for companies in the consumer services industry is lower than Fu Shou Yuan International Group's P/E.
Its relatively high P/E ratio indicates that Fu Shou Yuan International Group shareholders think it will perform better than other companies in its industry classification. The market is optimistic about the future, but that doesn't guarantee future growth. So further research is always essential. I often monitor director buying and selling.
How Growth Rates Impact P/E Ratios
Probably the most important factor in determining what P/E a company trades on is the earnings growth. 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. And as that P/E ratio drops, the company will look cheap, unless its share price increases.
Most would be impressed by Fu Shou Yuan International Group earnings growth of 13% in the last year. And it has bolstered its earnings per share by 17% per year over the last five years. This could arguably justify a relatively high P/E ratio.
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. In other words, it does not consider any debt or cash that the company may have on the balance sheet. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
While growth expenditure doesn't always pay off, the point is that it is a good option to have; but one that the P/E ratio ignores.
How Does Fu Shou Yuan International Group's Debt Impact Its P/E Ratio?
Fu Shou Yuan International Group has net cash of CN¥2.0b. This is fairly high at 15% of its market capitalization. That might mean balance sheet strength is important to the business, but should also help push the P/E a bit higher than it would otherwise be.
The Bottom Line On Fu Shou Yuan International Group's P/E Ratio
Fu Shou Yuan International Group trades on a P/E ratio of 26.0, which is above its market average of 10.6. Its strong balance sheet gives the company plenty of resources for extra growth, and it has already proven it can grow. Therefore it seems reasonable that the market would have relatively high expectations of the company
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. So this free visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.
But note: Fu Shou Yuan International 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).
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.