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This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). To keep it practical, we’ll show how Tao Heung Holdings Limited’s (HKG:573) P/E ratio could help you assess the value on offer. Tao Heung Holdings has a P/E ratio of 14.3, based on the last twelve months. That is equivalent to an earnings yield of about 7.0%.
How Do I Calculate A Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Tao Heung Holdings:
P/E of 14.3 = HK$1.4 ÷ HK$0.098 (Based on the year to June 2018.)
Is A High P/E 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 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 Growth Rates Impact P/E Ratios
Companies that shrink earnings per share quickly will rapidly decrease the ‘E’ in the equation. 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.
Tao Heung Holdings’s earnings per share fell by 21% in the last twelve months. And EPS is down 22% a year, over the last 5 years. This might lead to muted expectations.
How Does Tao Heung 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. The image below shows that Tao Heung Holdings has a P/E ratio that is roughly in line with the hospitality industry average (13.9).
That indicates that the market expects Tao Heung Holdings will perform roughly in line with other companies in its industry. The company could surprise by performing better than average, in the future. Further research into factors such asmanagement tenure, could help you form your own view on whether that is likely.
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. That means it doesn’t take debt or cash into account. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.
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 Tao Heung Holdings’s Debt Impact Its P/E Ratio?
Since Tao Heung Holdings holds net cash of HK$367m, it can spend on growth, justifying a higher P/E ratio than otherwise.
The Verdict On Tao Heung Holdings’s P/E Ratio
Tao Heung Holdings’s P/E is 14.3 which is above average (10.7) in the HK market. 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!
Investors have an opportunity when market expectations about a stock are wrong. People often underestimate remarkable growth — so investors can make money when fast growth is not fully appreciated. We don’t have analyst forecasts, but 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 Tao Heung Holdings. So you may wish to see this free collection of other companies that have grown earnings strongly.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at email@example.com.