Today, we’ll introduce the concept of the P/E ratio for those who are learning about investing. We’ll show how you can use KPa-BM Holdings Limited’s (HKG:2663) P/E ratio to inform your assessment of the investment opportunity. Looking at earnings over the last twelve months, KPa-BM Holdings has a P/E ratio of 3.64. In other words, at today’s prices, investors are paying HK$3.64 for every HK$1 in prior year profit.
How Do You Calculate A P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for KPa-BM Holdings:
P/E of 3.64 = HK$0.25 ÷ HK$0.07 (Based on the year to September 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 isn’t a good or a bad thing on its own, but a high P/E means that buyers have a higher opinion of the business’s prospects, relative to stocks with a lower P/E.
How Does KPa-BM Holdings’s P/E Ratio Compare To Its Peers?
One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. If you look at the image below, you can see KPa-BM Holdings has a lower P/E than the average (9.8) in the construction industry classification.
Its relatively low P/E ratio indicates that KPa-BM Holdings shareholders think it will struggle to do as well as other companies in its industry classification. Since the market seems unimpressed with KPa-BM Holdings, it’s quite possible it could surprise on the upside. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and selling.
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. If earnings are growing quickly, then the ‘E’ in the equation will increase faster than it would otherwise. And in that case, the P/E ratio itself will drop rather quickly. A lower P/E should indicate the stock is cheap relative to others — and that may attract buyers.
KPa-BM Holdings’s 59% EPS improvement over the last year was like bamboo growth after rain; rapid and impressive. The sweetener is that the annual five year growth rate of 21% is also impressive. So I’d be surprised if the P/E ratio was not above average.
Don’t Forget: The P/E Does Not Account For Debt or Bank Deposits
The ‘Price’ in P/E reflects the market capitalization of the company. 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.
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.
Is Debt Impacting KPa-BM Holdings’s P/E?
With net cash of HK$49m, KPa-BM Holdings has a very strong balance sheet, which may be important for its business. Having said that, at 33% of its market capitalization the cash hoard would contribute towards a higher P/E ratio.
The Verdict On KPa-BM Holdings’s P/E Ratio
KPa-BM Holdings trades on a P/E ratio of 3.6, which is below the HK market average of 10.7. Not only should the net cash position reduce risk, but the recent growth has been impressive. One might conclude that the market is a bit pessimistic, given the low P/E ratio.
Investors should be looking to buy stocks that the market is wrong about. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. Although we don’t have analyst forecasts you could get a better understanding of its growth by checking out this more detailed historical graph of earnings, revenue and cash flow.
Of course you might be able to find a better stock than KPa-BM Holdings. So you may wish to see this free collection of other companies that have grown earnings strongly.
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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