Despite Its High P/E Ratio, Is Quanzhou Huixin Micro-Credit Co., Ltd. (HKG:1577) Still Undervalued?

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The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We'll apply a basic P/E ratio analysis to Quanzhou Huixin Micro-Credit Co., Ltd.'s (HKG:1577), to help you decide if the stock is worth further research. Based on the last twelve months, Quanzhou Huixin Micro-Credit's P/E ratio is 9.43. In other words, at today's prices, investors are paying HK$9.43 for every HK$1 in prior year profit.

Check out our latest analysis for Quanzhou Huixin Micro-Credit

How Do I Calculate A 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 Quanzhou Huixin Micro-Credit:

P/E of 9.43 = CN¥1.22 (Note: this is the share price in the reporting currency, namely, CNY ) ÷ CN¥0.13 (Based on the trailing twelve months to December 2018.)

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. 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

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. A higher P/E should indicate the stock is expensive relative to others -- and that may encourage shareholders to sell.

Quanzhou Huixin Micro-Credit's earnings per share fell by 3.3% in the last twelve months. But EPS is up 1.8% over the last 5 years. And it has shrunk its earnings per share by 4.9% per year over the last three years. This growth rate might warrant a low P/E ratio. So you wouldn't expect a very high P/E.

How Does Quanzhou Huixin Micro-Credit's P/E Ratio Compare To Its Peers?

The P/E ratio indicates whether the market has higher or lower expectations of a company. As you can see below, Quanzhou Huixin Micro-Credit has a higher P/E than the average company (7.6) in the consumer finance industry.

Quanzhou Huixin Micro-Credit's P/E tells us that market participants think the company will perform better than its industry peers, going forward. The market is optimistic about the future, but that doesn't guarantee future growth. So investors 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

One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. 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.

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.

Quanzhou Huixin Micro-Credit's Balance Sheet

Net debt totals 12% of Quanzhou Huixin Micro-Credit's market cap. 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 Quanzhou Huixin Micro-Credit's P/E Ratio

Quanzhou Huixin Micro-Credit's P/E is 9.4 which is below average (10.8) in the HK market. Since it only carries a modest debt load, it's likely the low expectations implied by the P/E ratio arise from the lack of recent earnings growth.

When the market is wrong about a stock, it gives savvy investors an opportunity. 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.' We don't have analyst forecasts, but shareholders might want to examine this detailed historical graph of earnings, revenue and cash flow.

But note: Quanzhou Huixin Micro-Credit 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.