This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We'll look at Watts International Maritime Engineering Limited's (HKG:2258) P/E ratio and reflect on what it tells us about the company's share price. What is Watts International Maritime Engineering's P/E ratio? Well, based on the last twelve months it is 7.00. In other words, at today's prices, investors are paying HK$7.00 for every HK$1 in prior year profit.
How Do I Calculate A Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share (in the reporting currency) ÷ Earnings per Share (EPS)
Or for Watts International Maritime Engineering:
P/E of 7.00 = HK$1.00 (Note: this is the share price in the reporting currency, namely, CNY ) ÷ HK$0.14 (Based on the year to June 2019.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio means that investors are paying a higher price for each HK$1 of company earnings. 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 Watts International Maritime Engineering Have A Relatively High Or Low P/E For Its Industry?
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 Watts International Maritime Engineering has a lower P/E than the average (10.2) in the construction industry classification.
Watts International Maritime Engineering'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 Watts International Maritime Engineering, 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. When earnings grow, the 'E' increases, over time. And in that case, the P/E ratio itself will drop rather quickly. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.
Watts International Maritime Engineering saw earnings per share decrease by 5.8% last year.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. In other words, it does not consider any debt or cash that the company may have on the balance sheet. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.
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).
So What Does Watts International Maritime Engineering's Balance Sheet Tell Us?
With net cash of CN¥437m, Watts International Maritime Engineering has a very strong balance sheet, which may be important for its business. Having said that, at 55% of its market capitalization the cash hoard would contribute towards a higher P/E ratio.
The Bottom Line On Watts International Maritime Engineering's P/E Ratio
Watts International Maritime Engineering has a P/E of 7.0. That's below the average in the HK market, which is 10.5. Falling earnings per share are likely to be keeping potential buyers away, but the net cash position means the company has time to improve: if so, the low P/E could be an opportunity.
Investors have an opportunity when market expectations about a stock are wrong. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. Although we don't have analyst forecasts you could get a better understanding of its growth by checking out this more detailed historical graph of earnings, revenue and cash flow.
Of course you might be able to find a better stock than Watts International Maritime Engineering. 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.
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