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This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We'll look at Asia Allied Infrastructure Holdings Limited's (HKG:711) P/E ratio and reflect on what it tells us about the company's share price. Based on the last twelve months, Asia Allied Infrastructure Holdings's P/E ratio is 7.69. That means that at current prices, buyers pay HK$7.69 for every HK$1 in trailing yearly profits.
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 Asia Allied Infrastructure Holdings:
P/E of 7.69 = HK$0.69 ÷ HK$0.090 (Based on the year to September 2018.)
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 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 Growth Rates Impact P/E Ratios
Companies that shrink earnings per share quickly will rapidly decrease the 'E' in the equation. That means even if the current P/E is low, it will increase over time if the share price stays flat. So while a stock may look cheap based on past earnings, it could be expensive based on future earnings.
Asia Allied Infrastructure Holdings shrunk earnings per share by 39% over the last year. And EPS is down 1.1% a year, over the last 5 years. This could justify a pessimistic P/E.
How Does Asia Allied Infrastructure Holdings's P/E Ratio Compare To Its Peers?
We can get an indication of market expectations by looking at the P/E ratio. If you look at the image below, you can see Asia Allied Infrastructure Holdings has a lower P/E than the average (11.1) in the construction industry classification.
Its relatively low P/E ratio indicates that Asia Allied Infrastructure Holdings shareholders think it will struggle to do as well as other companies in its industry classification. Since the market seems unimpressed with Asia Allied Infrastructure Holdings, it's quite possible it could surprise on the upside. You should delve deeper. I like to check if company insiders have been buying or selling.
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.
While growth expenditure doesn't always pay off, the point is that it is a good option to have; but one that the P/E ratio ignores.
How Does Asia Allied Infrastructure Holdings's Debt Impact Its P/E Ratio?
Asia Allied Infrastructure Holdings has net debt worth 70% of its market capitalization. This is enough debt that you'd have to make some adjustments before using the P/E ratio to compare it to a company with net cash.
The Bottom Line On Asia Allied Infrastructure Holdings's P/E Ratio
Asia Allied Infrastructure Holdings's P/E is 7.7 which is below average (11.3) in the HK market. When you consider that the company has significant debt, and didn't grow EPS last year, it isn't surprising that the market has muted 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. Although we don't have analyst forecasts, shareholders might want to examine this detailed historical graph of earnings, revenue and cash flow.
Of course you might be able to find a better stock than Asia Allied Infrastructure 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 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. Thank you for reading.