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 Tian Chang Group Holdings Ltd.'s (HKG:2182), to help you decide if the stock is worth further research. Looking at earnings over the last twelve months, Tian Chang Group Holdings has a P/E ratio of 5.94. That is equivalent to an earnings yield of about 17%.
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 Tian Chang Group Holdings:
P/E of 5.94 = HK$0.76 ÷ HK$0.13 (Based on the year to December 2018.)
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.
How Does Tian Chang Group Holdings's P/E Ratio Compare To Its Peers?
We can get an indication of market expectations by looking at the P/E ratio. If you look at the image below, you can see Tian Chang Group Holdings has a lower P/E than the average (7.7) in the chemicals industry classification.
Tian Chang Group Holdings's P/E tells us that market participants think it will not fare as well as its peers in the same industry. Since the market seems unimpressed with Tian Chang Group Holdings, it's quite possible it could surprise on the upside. You should delve deeper. I like to check if company insiders have been buying or 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. That's because companies that grow earnings per share quickly will rapidly increase the 'E' in the equation. 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.
In the last year, Tian Chang Group Holdings grew EPS like Taylor Swift grew her fan base back in 2010; the 196% gain was both fast and well deserved. And earnings per share have improved by 50% annually, over the last three years. So we'd absolutely expect it to have a relatively high P/E ratio.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
Don't forget that the P/E ratio considers market capitalization. That means it doesn't take debt or cash into account. 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.
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.
Is Debt Impacting Tian Chang Group Holdings's P/E?
Net debt totals 24% of Tian Chang Group Holdings's market cap. This could bring some additional risk, and reduce the number of investment options for management; worth remembering if you compare its P/E to businesses without debt.
The Bottom Line On Tian Chang Group Holdings's P/E Ratio
Tian Chang Group Holdings's P/E is 5.9 which is below average (9.9) in the HK market. The company hasn't stretched its balance sheet, and earnings growth was good last year. The low P/E ratio suggests current market expectations are muted, implying these levels of growth will not continue.
Investors have an opportunity when market expectations about a stock are wrong. 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.' We don't have analyst forecasts, but 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 Tian Chang Group Holdings. 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).
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If you spot an error that warrants correction, please contact the editor at email@example.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.