This article is written for those who want to get better at using price to earnings ratios (P/E ratios). To keep it practical, we’ll show how TK Group (Holdings) Limited’s (HKG:2283) P/E ratio could help you assess the value on offer. What is TK Group (Holdings)’s P/E ratio? Well, based on the last twelve months it is 10.47. In other words, at today’s prices, investors are paying HK$10.47 for every HK$1 in prior year profit.
How Do I Calculate A Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for TK Group (Holdings):
P/E of 10.47 = HKD4.07 ÷ HKD0.39 (Based on the trailing twelve months to June 2019.)
Is A High P/E 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.
How Does TK Group (Holdings)’s P/E Ratio Compare To Its Peers?
We can get an indication of market expectations by looking at the P/E ratio. We can see in the image below that the average P/E (11.3) for companies in the machinery industry is higher than TK Group (Holdings)’s P/E.
TK Group (Holdings)’s P/E tells us that market participants think it will not fare as well as its peers in the same industry. Since the market seems unimpressed with TK Group (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
P/E ratios primarily reflect market expectations around earnings growth rates. If earnings are growing quickly, then the ‘E’ in the equation will increase faster than it would otherwise. That means even if the current P/E is high, it will reduce over time if the share price stays flat. And as that P/E ratio drops, the company will look cheap, unless its share price increases.
TK Group (Holdings)’s earnings per share fell by 2.4% in the last twelve months. But it has grown its earnings per share by 16% per year over the last five years.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
Don’t forget that the P/E ratio considers market capitalization. So it won’t reflect the advantage of cash, or disadvantage of debt. 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).
TK Group (Holdings)’s Balance Sheet
Since TK Group (Holdings) holds net cash of HK$173m, it can spend on growth, justifying a higher P/E ratio than otherwise.
The Bottom Line On TK Group (Holdings)’s P/E Ratio
TK Group (Holdings) has a P/E of 10.5. That’s around the same as the average in the HK market, which is 10.5. While the absence of growth in the last year is probably causing a degree of pessimism, the net cash position means it’s not surprising that expectations put the company roughly in line with the market average P/E.
Investors have an opportunity when market expectations about a stock are wrong. 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: TK Group (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 firstname.lastname@example.org. 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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