This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We'll look at Palace Banquet Holdings Limited's (HKG:1703) P/E ratio and reflect on what it tells us about the company's share price. Palace Banquet Holdings has a price to earnings ratio of 11.84, based on the last twelve months. That means that at current prices, buyers pay HK$11.84 for every HK$1 in trailing yearly profits.
How Do I Calculate A Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Palace Banquet Holdings:
P/E of 11.84 = HKD0.31 ÷ HKD0.03 (Based on the trailing twelve months to September 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 HKD1 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.
How Does Palace Banquet Holdings's P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. The image below shows that Palace Banquet Holdings has a lower P/E than the average (12.9) P/E for companies in the hospitality industry.
This suggests that market participants think Palace Banquet Holdings will underperform other companies in its industry. Since the market seems unimpressed with Palace Banquet 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.
How Growth Rates Impact P/E Ratios
Companies that shrink earnings per share quickly will rapidly decrease the 'E' in the equation. That means unless the share price falls, the P/E will increase in a few years. Then, a higher P/E might scare off shareholders, pushing the share price down.
Palace Banquet Holdings shrunk earnings per share by 56% over the last year. And EPS is down 14% a year, over the last 5 years. This growth rate might warrant a below average P/E ratio.
Remember: P/E Ratios Don't Consider The Balance Sheet
It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. In other words, it does not consider any debt or cash that the company may have on the balance sheet. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.
Such spending might be good or bad, overall, but the key point here is that you need to look at debt to understand the P/E ratio in context.
Is Debt Impacting Palace Banquet Holdings's P/E?
Palace Banquet Holdings has net cash of HK$142m. This is fairly high at 46% of its market capitalization. That might mean balance sheet strength is important to the business, but should also help push the P/E a bit higher than it would otherwise be.
The Verdict On Palace Banquet Holdings's P/E Ratio
Palace Banquet Holdings trades on a P/E ratio of 11.8, which is above its market average of 10.6. Falling earnings per share is probably keeping traditional value investors away, but the relatively strong balance sheet will allow the company time to invest in growth. Clearly, the high P/E indicates shareholders think it will!
When the market is wrong about a stock, it gives savvy investors an opportunity. People often underestimate remarkable growth -- so investors can make money when fast growth is not fully appreciated. We don't have analyst forecasts, but shareholders might want to examine this detailed historical graph of earnings, revenue and cash flow.
But note: Palace Banquet Holdings 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).
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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