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The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). To keep it practical, we'll show how Hong Kong Economic Times Holdings Limited's (HKG:423) P/E ratio could help you assess the value on offer. Looking at earnings over the last twelve months, Hong Kong Economic Times Holdings has a P/E ratio of 9.9. In other words, at today's prices, investors are paying HK$9.9 for every HK$1 in prior year profit.
How Do I Calculate A Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Hong Kong Economic Times Holdings:
P/E of 9.9 = HK$1.64 ÷ HK$0.17 (Based on the trailing twelve months to March 2019.)
Is A High Price-to-Earnings 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 isn't necessarily good or bad, but a high P/E implies relatively high expectations of what a company can achieve in the future.
Does Hong Kong Economic Times Holdings Have A Relatively High Or Low P/E For Its Industry?
The P/E ratio essentially measures market expectations of a company. If you look at the image below, you can see Hong Kong Economic Times Holdings has a lower P/E than the average (17.2) in the media industry classification.
This suggests that market participants think Hong Kong Economic Times Holdings will underperform other companies in its industry. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and selling.
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. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
Hong Kong Economic Times Holdings's earnings per share were pretty steady over the last year. But over the longer term (5 years) earnings per share have increased by 21%.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
Don't forget that the P/E ratio considers market capitalization. So it won't reflect the advantage of cash, or disadvantage of debt. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
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 Hong Kong Economic Times Holdings's Balance Sheet Tell Us?
With net cash of HK$330m, Hong Kong Economic Times Holdings has a very strong balance sheet, which may be important for its business. Having said that, at 47% of its market capitalization the cash hoard would contribute towards a higher P/E ratio.
The Bottom Line On Hong Kong Economic Times Holdings's P/E Ratio
Hong Kong Economic Times Holdings's P/E is 9.9 which is below average (10.7) in the HK market. Earnings improved over the last year. And the healthy balance sheet means the company can sustain growth while the P/E suggests shareholders don't think it will.
Investors have an opportunity when market expectations about a stock are wrong. 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.' Although we don't have analyst forecasts, 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 Hong Kong Economic Times Holdings. So you may wish to see this free collection of other companies that have grown earnings strongly.
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.