Is Shandong Weigao Group Medical Polymer Company Limited's (HKG:1066) High P/E Ratio A Problem For Investors?

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This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We'll show how you can use Shandong Weigao Group Medical Polymer Company Limited's (HKG:1066) P/E ratio to inform your assessment of the investment opportunity. Shandong Weigao Group Medical Polymer has a P/E ratio of 19.49, based on the last twelve months. That means that at current prices, buyers pay HK$19.49 for every HK$1 in trailing yearly profits.

Check out our latest analysis for Shandong Weigao Group Medical Polymer

How Do I Calculate Shandong Weigao Group Medical Polymer's Price To Earnings Ratio?

The formula for price to earnings is:

Price to Earnings Ratio = Share Price (in reporting currency) ÷ Earnings per Share (EPS)

Or for Shandong Weigao Group Medical Polymer:

P/E of 19.49 = CN¥6.41 (Note: this is the share price in the reporting currency, namely, CNY ) ÷ CN¥0.33 (Based on the trailing twelve months to December 2018.)

Is A High Price-to-Earnings Ratio Good?

A higher P/E ratio implies that investors pay a higher price for the earning power of the business. All else being equal, it's better to pay a low price -- but as Warren Buffett said, 'It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price.'

How Growth Rates Impact P/E Ratios

P/E ratios primarily reflect market expectations around earnings growth rates. 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.

It's great to see that Shandong Weigao Group Medical Polymer grew EPS by 17% in the last year. And its annual EPS growth rate over 5 years is 18%. With that performance, you might expect an above average P/E ratio.

How Does Shandong Weigao Group Medical Polymer's P/E Ratio Compare To Its Peers?

The P/E ratio essentially measures market expectations of a company. As you can see below, Shandong Weigao Group Medical Polymer has a higher P/E than the average company (14.2) in the medical equipment industry.

SEHK:1066 Price Estimation Relative to Market, April 1st 2019

Shandong Weigao Group Medical Polymer's P/E tells us that market participants think the company will perform better than its industry peers, going forward. 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.

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

Don't forget that the P/E ratio considers market capitalization. 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 expenditure might be good or bad, in the long term, but the point here is that the balance sheet is not reflected by this ratio.

Shandong Weigao Group Medical Polymer's Balance Sheet

Shandong Weigao Group Medical Polymer has net debt worth just 4.1% of its market capitalization. The market might award it a higher P/E ratio if it had net cash, but its unlikely this low level of net borrowing is having a big impact on the P/E multiple.

The Bottom Line On Shandong Weigao Group Medical Polymer's P/E Ratio

Shandong Weigao Group Medical Polymer has a P/E of 19.5. That's higher than the average in the HK market, which is 11.6. While the company does use modest debt, its recent earnings growth is impressive. Therefore it seems reasonable that the market would have relatively high expectations of the company

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 report on the analyst consensus forecasts could help you make a master move on this stock.

But note: Shandong Weigao Group Medical Polymer 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).

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 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. Thank you for reading.