This article is written for those who want to get better at using price to earnings ratios (P/E ratios). To keep it practical, we'll show how MicroPort Scientific Corporation's (HKG:853) P/E ratio could help you assess the value on offer. What is MicroPort Scientific's P/E ratio? Well, based on the last twelve months it is 29.73. That means that at current prices, buyers pay HK$29.73 for every HK$1 in trailing yearly profits.
How Do You Calculate MicroPort Scientific'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 MicroPort Scientific:
P/E of 29.73 = USD1.27 (Note: this is the share price in the reporting currency, namely, USD ) ÷ USD0.04 (Based on the trailing twelve months to June 2019.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio means that investors are paying a higher price for each USD1 of company earnings. 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 MicroPort Scientific'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 MicroPort Scientific has a higher P/E than the average (17.9) P/E for companies in the medical equipment industry.
That means that the market expects MicroPort Scientific will outperform other companies in its industry. Shareholders are clearly optimistic, but the future is always uncertain. So investors should delve deeper. I like to check if company insiders have been buying or selling.
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. When earnings grow, the 'E' increases, over time. And in that case, the P/E ratio itself will drop rather quickly. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.
In the last year, MicroPort Scientific grew EPS like Taylor Swift grew her fan base back in 2010; the 191% gain was both fast and well deserved.
Remember: P/E Ratios Don't Consider The Balance Sheet
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. In other words, it does not consider any debt or cash that the company may have on the balance sheet. 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).
MicroPort Scientific's Balance Sheet
MicroPort Scientific has net debt worth 10% of its market capitalization. That's enough debt to impact the P/E ratio a little; so keep it in mind if you're comparing it to companies without debt.
The Bottom Line On MicroPort Scientific's P/E Ratio
MicroPort Scientific has a P/E of 29.7. That's significantly higher than the average in its market, which is 9.9. While the company does use modest debt, its recent earnings growth is superb. So on this analysis a high P/E ratio seems reasonable.
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. 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.
If you spot an error that warrants correction, please contact the editor at email@example.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.
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