Despite Its High P/E Ratio, Is Wang Yang Holdings Limited (HKG:1735) Still Undervalued?

This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We’ll look at Wang Yang Holdings Limited’s (HKG:1735) P/E ratio and reflect on what it tells us about the company’s share price. Wang Yang Holdings has a price to earnings ratio of 53.29, based on the last twelve months. That means that at current prices, buyers pay HK$53.29 for every HK$1 in trailing yearly profits.

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How Do You Calculate A P/E Ratio?

The formula for P/E is:

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

Or for Wang Yang Holdings:

P/E of 53.29 = HK$2.19 ÷ HK$0.041 (Based on the trailing twelve months to September 2018.)

Is A High P/E Ratio Good?

A higher P/E ratio implies that investors pay a higher price for the earning power of the business. That is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.

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. That means even if the current P/E is high, it will reduce over time if the share price stays flat. A lower P/E should indicate the stock is cheap relative to others — and that may attract buyers.

Wang Yang Holdings shrunk earnings per share by 61% over the last year.

How Does Wang Yang 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, Wang Yang Holdings has a much higher P/E than the average company (10.4) in the construction industry.

Its relatively high P/E ratio indicates that Wang Yang Holdings shareholders think it will perform better than other companies in its industry classification. Clearly the market expects growth, but it isn’t guaranteed. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.

A Limitation: P/E Ratios Ignore Debt and Cash In The Bank

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.

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).

Wang Yang Holdings’s Balance Sheet

Since Wang Yang Holdings holds net cash of HK$72m, it can spend on growth, justifying a higher P/E ratio than otherwise.

The Verdict On Wang Yang Holdings’s P/E Ratio

Wang Yang Holdings trades on a P/E ratio of 53.3, which is multiples above the HK market average of 10.5. The recent drop in earnings per share would make some investors cautious, 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 should be looking to buy stocks that the market is wrong about. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. 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 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.

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 editorial-team@simplywallst.com.