The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We’ll look at LexinFintech Holdings Ltd.’s (NASDAQ:LX) P/E ratio and reflect on what it tells us about the company’s share price. What is LexinFintech Holdings’s P/E ratio? Well, based on the last twelve months it is 5.46. That corresponds to an earnings yield of approximately 18%.
How Do You Calculate A P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share (in the reporting currency) ÷ Earnings per Share (EPS)
Or for LexinFintech Holdings:
P/E of 5.46 = CN¥75.84 (Note: this is the share price in the reporting currency, namely, CNY ) ÷ CN¥13.89 (Based on the year to March 2019.)
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. 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 Does LexinFintech Holdings’s P/E Ratio Compare To Its Peers?
We can get an indication of market expectations by looking at the P/E ratio. If you look at the image below, you can see LexinFintech Holdings has a lower P/E than the average (9.2) in the consumer finance industry classification.
This suggests that market participants think LexinFintech Holdings will underperform other companies in its industry.
How Growth Rates Impact P/E Ratios
Generally speaking the rate of earnings growth has a profound impact on a company’s P/E multiple. When earnings grow, the ‘E’ increases, over time. 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.
LexinFintech Holdings’s earnings made like a rocket, taking off 490% last year.
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. The exact same company would hypothetically deserve a higher P/E ratio if it had a strong balance sheet, than if it had a weak one with lots of debt, because a cashed up company can spend on growth.
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).
So What Does LexinFintech Holdings’s Balance Sheet Tell Us?
LexinFintech Holdings’s net debt is 21% of its market cap. That’s enough debt to impact the P/E ratio a little; so keep it in mind if you’re comparing it to companies without debt.
The Verdict On LexinFintech Holdings’s P/E Ratio
LexinFintech Holdings has a P/E of 5.5. That’s below the average in the US market, which is 17.4. The EPS growth last year was strong, and debt levels are quite reasonable. If the company can continue to grow earnings, then the current P/E may be unjustifiably low.
When the market is wrong about a stock, it gives savvy investors an opportunity. If the reality for a company is not as bad as the P/E ratio indicates, then the share price should increase as the market realizes this. So this free report on the analyst consensus forecasts could help you make a master move on this stock.
But note: LexinFintech 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).
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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. Thank you for reading.