Here's What Legend Holdings Corporation's (HKG:3396) P/E Ratio Is Telling Us

Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll show how you can use Legend Holdings Corporation's (HKG:3396) P/E ratio to inform your assessment of the investment opportunity. Looking at earnings over the last twelve months, Legend Holdings has a P/E ratio of 8.66. That corresponds to an earnings yield of approximately 11.6%.

View our latest analysis for Legend Holdings

How Do You Calculate Legend 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 Legend Holdings:

P/E of 8.66 = HK$14.87 (Note: this is the share price in the reporting currency, namely, CNY ) ÷ HK$1.72 (Based on the trailing twelve months to June 2019.)

Is A High Price-to-Earnings Ratio Good?

The higher the P/E ratio, the higher the price tag of a business, relative to its trailing 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 Does Legend 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. If you look at the image below, you can see Legend Holdings has a lower P/E than the average (9.7) in the tech industry classification.

Its relatively low P/E ratio indicates that Legend Holdings shareholders think it will struggle to do as well as other companies in its industry classification. Many investors like to buy stocks when the market is pessimistic about their prospects. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.

How Growth Rates Impact P/E Ratios

Earnings growth rates have a big influence on P/E ratios. Earnings growth means that in the future the 'E' will be higher. That means unless the share price increases, the P/E will reduce in a few years. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.

Legend Holdings shrunk earnings per share by 22% over the last year. But it has grown its earnings per share by 19% per year over the last three years. And over the longer term (5 years) earnings per share have decreased 7.2% annually. This might lead to muted expectations.

Don't Forget: The P/E Does Not Account For Debt or Bank Deposits

One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. So it won't reflect the advantage of cash, or disadvantage of debt. The exact same company would hypothetically deserve a higher P/E ratio if it had a strong balance sheet, than if it had a weak one with lots of debt, because a cashed up company can spend on 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).

So What Does Legend Holdings's Balance Sheet Tell Us?

Net debt totals a substantial 232% of Legend Holdings's market cap. 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 Verdict On Legend Holdings's P/E Ratio

Legend Holdings trades on a P/E ratio of 8.7, which is below the HK market average of 10.2. Given meaningful debt, and a lack of recent growth, the market looks to be extrapolating this recent performance; reflecting low expectations for the future.

Investors should be looking to buy stocks that the market is wrong about. 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. So this free visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.

You might be able to find a better buy than Legend Holdings. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).

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.