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Why Royale Furniture Holdings Limited's (HKG:1198) High P/E Ratio Isn't Necessarily A Bad Thing

Simply Wall St

This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We'll look at Royale Furniture Holdings Limited's (HKG:1198) P/E ratio and reflect on what it tells us about the company's share price. What is Royale Furniture Holdings's P/E ratio? Well, based on the last twelve months it is 49.05. That is equivalent to an earnings yield of about 2.0%.

Check out our latest analysis for Royale Furniture Holdings

How Do You Calculate A P/E Ratio?

The formula for P/E is:

Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)

Or for Royale Furniture Holdings:

P/E of 49.05 = HKD1.23 ÷ HKD0.03 (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 necessarily good or bad, but a high P/E implies relatively high expectations of what a company can achieve in the future.

How Does Royale Furniture Holdings's P/E Ratio Compare To Its Peers?

The P/E ratio essentially measures market expectations of a company. The image below shows that Royale Furniture Holdings has a significantly higher P/E than the average (13.4) P/E for companies in the consumer durables industry.

SEHK:1198 Price Estimation Relative to Market, January 16th 2020

Its relatively high P/E ratio indicates that Royale Furniture Holdings shareholders think it will perform better than other companies in its industry classification. Shareholders are clearly optimistic, but the future is always uncertain. 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. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. That means even if the current P/E is high, it will reduce over time if the share price stays flat. Then, a lower P/E should attract more buyers, pushing the share price up.

Royale Furniture Holdings had pretty flat EPS growth in the last year.

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. Thus, the metric does not reflect cash or debt held by the company. Theoretically, a business can improve its earnings (and produce a lower P/E in the future) by investing in growth. That means taking on debt (or spending its cash).

Such spending might be good or bad, overall, but the key point here is that you need to look at debt to understand the P/E ratio in context.

How Does Royale Furniture Holdings's Debt Impact Its P/E Ratio?

Net debt totals 12% of Royale Furniture 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 Verdict On Royale Furniture Holdings's P/E Ratio

Royale Furniture Holdings's P/E is 49.0 which is way above average (10.5) in its market. With debt at prudent levels and improving earnings, it's fair to say the market expects steady progress in the future.

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. 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 find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.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.

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.