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Why Vtech Holdings Limited's (HKG:303) 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 Vtech Holdings Limited's (HKG:303) P/E ratio and reflect on what it tells us about the company's share price. Looking at earnings over the last twelve months, Vtech Holdings has a P/E ratio of 13. In other words, at today's prices, investors are paying HK$13 for every HK$1 in prior year profit.

Check out our latest analysis for Vtech Holdings

How Do You Calculate Vtech Holdings'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 Vtech Holdings:

P/E of 13 = $8.86 (Note: this is the share price in the reporting currency, namely, USD ) ÷ $0.68 (Based on the year to March 2019.)

Is A High P/E Ratio Good?

The higher the P/E ratio, the higher the price tag of a business, relative to its trailing 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.

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

The P/E ratio indicates whether the market has higher or lower expectations of a company. As you can see below Vtech Holdings has a P/E ratio that is fairly close for the average for the communications industry, which is 12.1.

SEHK:303 Price Estimation Relative to Market, July 29th 2019

Its P/E ratio suggests that Vtech Holdings shareholders think that in the future it will perform about the same as other companies in its industry classification. So if Vtech Holdings actually outperforms its peers going forward, that should be a positive for the share price. Checking factors such as director buying and selling. could help you form your own view on if that will happen.

How Growth Rates Impact P/E Ratios

If earnings fall then in the future the 'E' will be lower. That means even if the current P/E is low, it will increase over time if the share price stays flat. So while a stock may look cheap based on past earnings, it could be expensive based on future earnings.

Vtech Holdings shrunk earnings per share by 17% over the last year. And EPS is down 3.5% a year, over the last 5 years. This might lead to muted expectations.

Remember: P/E Ratios Don't Consider The Balance Sheet

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. 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).

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.

Vtech Holdings's Balance Sheet

Vtech Holdings has net cash of US$237m. This is fairly high at 11% 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 Vtech Holdings's P/E Ratio

Vtech Holdings has a P/E of 13. That's higher than the average in its market, which is 10.6. Falling earnings per share is probably keeping traditional value investors away, but the relatively strong balance sheet will allow the company time to invest in growth. Clearly, the high P/E indicates shareholders think it will!

When the market is wrong about a stock, it gives savvy investors an opportunity. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.

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.

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.

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. Thank you for reading.