Today, we’ll introduce the concept of the P/E ratio for those who are learning about investing. We’ll look at Wah Fu Education Group Limited’s (NASDAQ:WAFU) P/E ratio and reflect on what it tells us about the company’s share price. Looking at earnings over the last twelve months, Wah Fu Education Group has a P/E ratio of 13.66. That is equivalent to an earnings yield of about 7.3%.
How Do You Calculate A P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Wah Fu Education Group:
P/E of 13.66 = $2.91 ÷ $0.21 (Based on the trailing twelve months to September 2018.)
Is A High Price-to-Earnings Ratio Good?
The higher the P/E ratio, the higher the price tag of a business, relative to its trailing earnings. That is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.
Does Wah Fu Education Group Have A Relatively High Or Low P/E For Its Industry?
The P/E ratio essentially measures market expectations of a company. We can see in the image below that the average P/E (25.7) for companies in the consumer services industry is higher than Wah Fu Education Group’s P/E.
Its relatively low P/E ratio indicates that Wah Fu Education Group shareholders think it will struggle to do as well as other companies in its industry classification.
How Growth Rates Impact P/E Ratios
When earnings fall, the ‘E’ decreases, over time. That means unless the share price falls, the P/E will increase in a few years. A higher P/E should indicate the stock is expensive relative to others — and that may encourage shareholders to sell.
Wah Fu Education Group increased earnings per share by 6.8% last year. But earnings per share are down 21% per year over the last five years.
Don’t Forget: The P/E Does Not Account For Debt or Bank Deposits
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. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
Spending on growth might be good or bad a few years later, but the point is that the P/E ratio does not account for the option (or lack thereof).
Wah Fu Education Group’s Balance Sheet
With net cash of US$4.1m, Wah Fu Education Group has a very strong balance sheet, which may be important for its business. Having said that, at 32% of its market capitalization the cash hoard would contribute towards a higher P/E ratio.
The Verdict On Wah Fu Education Group’s P/E Ratio
Wah Fu Education Group has a P/E of 13.7. That’s below the average in the US market, which is 17.9. Recent earnings growth wasn’t bad. And the healthy balance sheet means the company can sustain growth while the P/E suggests shareholders don’t think it will.
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.’ 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 Wah Fu Education Group. 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.