Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll look at Midea Real Estate Holding Limited's (HKG:3990) P/E ratio and reflect on what it tells us about the company's share price. Looking at earnings over the last twelve months, Midea Real Estate Holding has a P/E ratio of 5.79. In other words, at today's prices, investors are paying HK$5.79 for every HK$1 in prior year profit.
How Do You Calculate Midea Real Estate Holding's P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Share Price (in reporting currency) ÷ Earnings per Share (EPS)
Or for Midea Real Estate Holding:
P/E of 5.79 = HK$17.85 (Note: this is the share price in the reporting currency, namely, CNY ) ÷ HK$3 (Based on the trailing twelve months to June 2019.)
Is A High P/E Ratio Good?
A higher P/E ratio means that buyers have to pay a higher price for each HK$1 the company has earned over the last year. 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 Does Midea Real Estate Holding's P/E Ratio Compare To Its Peers?
One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. The image below shows that Midea Real Estate Holding has a P/E ratio that is roughly in line with the real estate industry average (6.1).
Midea Real Estate Holding's P/E tells us that market participants think its prospects are roughly in line with its industry. The company could surprise by performing better than average, in the future. Further research into factors such as insider buying and selling, could help you form your own view on whether that is likely.
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 unless the share price increases, the P/E will reduce in a few years. And as that P/E ratio drops, the company will look cheap, unless its share price increases.
Midea Real Estate Holding's earnings per share grew by -9.1% in the last twelve months. And it has bolstered its earnings per share by 43% per year over the last five years.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
Don't forget that the P/E ratio considers market capitalization. Thus, the metric does not reflect cash or debt held by the company. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.
Such expenditure might be good or bad, in the long term, but the point here is that the balance sheet is not reflected by this ratio.
So What Does Midea Real Estate Holding's Balance Sheet Tell Us?
Midea Real Estate Holding has net debt worth a very significant 128% of its market capitalization. This level of debt justifies a relatively low P/E, so remain cognizant of the debt, if you're comparing it to other stocks.
The Bottom Line On Midea Real Estate Holding's P/E Ratio
Midea Real Estate Holding trades on a P/E ratio of 5.8, which is below the HK market average of 10.5. While the recent EPS growth is a positive, the significant amount of debt on the balance sheet may be contributing to pessimistic market expectations.
Investors have an opportunity when market expectations about a stock are wrong. If the reality for a company is not as bad as the P/E ratio indicates, then the share price should increase as the market realizes this. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.
But note: Midea Real Estate Holding may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio 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 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. Thank you for reading.