Should You Be Tempted To Sell Wenzhou Kangning Hospital Co., Ltd. (HKG:2120) Because Of Its P/E Ratio?

This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). To keep it practical, we'll show how Wenzhou Kangning Hospital Co., Ltd.'s (HKG:2120) P/E ratio could help you assess the value on offer. Based on the last twelve months, Wenzhou Kangning Hospital's P/E ratio is 14.80. That corresponds to an earnings yield of approximately 6.8%.

View our latest analysis for Wenzhou Kangning Hospital

How Do I Calculate A Price To Earnings Ratio?

The formula for P/E is:

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

Or for Wenzhou Kangning Hospital:

P/E of 14.80 = HK$18.37 (Note: this is the share price in the reporting currency, namely, CNY ) ÷ HK$1.24 (Based on the year to June 2019.)

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. 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 Wenzhou Kangning Hospital's P/E Ratio Compare To Its Peers?

The P/E ratio essentially measures market expectations of a company. The image below shows that Wenzhou Kangning Hospital has a P/E ratio that is roughly in line with the healthcare industry average (14.4).

That indicates that the market expects Wenzhou Kangning Hospital will perform roughly in line with other companies in its industry. So if Wenzhou Kangning Hospital actually outperforms its peers going forward, that should be a positive for the share price. I would further inform my view by checking insider buying and selling., among other things.

How Growth Rates Impact P/E Ratios

P/E ratios primarily reflect market expectations around earnings growth rates. That's because companies that grow earnings per share quickly will rapidly increase the 'E' in the equation. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. And as that P/E ratio drops, the company will look cheap, unless its share price increases.

It's nice to see that Wenzhou Kangning Hospital grew EPS by a stonking 40% in the last year. And earnings per share have improved by 9.9% annually, over the last five years. With that performance, I would expect it to have an above average P/E ratio.

A Limitation: P/E Ratios Ignore Debt and Cash In The Bank

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. 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.

So What Does Wenzhou Kangning Hospital's Balance Sheet Tell Us?

Wenzhou Kangning Hospital has net debt worth 11% of its market capitalization. This could bring some additional risk, and reduce the number of investment options for management; worth remembering if you compare its P/E to businesses without debt.

The Verdict On Wenzhou Kangning Hospital's P/E Ratio

Wenzhou Kangning Hospital has a P/E of 14.8. That's higher than the average in its market, which is 10.1. Its debt levels do not imperil its balance sheet and its EPS growth is very healthy indeed. So to be frank we are not surprised it has a high P/E ratio.

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

But note: Wenzhou Kangning Hospital 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 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.

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