This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We’ll look at Time Watch Investments Limited’s (HKG:2033) P/E ratio and reflect on what it tells us about the company’s share price. Time Watch Investments has a P/E ratio of 5.22, based on the last twelve months. In other words, at today’s prices, investors are paying HK$5.22 for every HK$1 in prior year profit.
How Do You Calculate A P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Time Watch Investments:
P/E of 5.22 = HK$0.780 ÷ HK$0.149 (Based on the year to December 2019.)
(Note: the above calculation results may not be precise due to rounding.)
Is A High P/E 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. That isn’t necessarily good or bad, but a high P/E implies relatively high expectations of what a company can achieve in the future.
Does Time Watch Investments Have A Relatively High Or Low P/E For Its Industry?
The P/E ratio indicates whether the market has higher or lower expectations of a company. The image below shows that Time Watch Investments has a lower P/E than the average (7.2) P/E for companies in the luxury industry.
Time Watch Investments’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 Time Watch Investments, 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. When earnings grow, the ‘E’ increases, over time. That means unless the share price increases, the P/E will reduce in a few years. A lower P/E should indicate the stock is cheap relative to others — and that may attract buyers.
It’s great to see that Time Watch Investments grew EPS by 17% in the last year. And it has improved its earnings per share by 11% per year over the last three years. So one might expect an above average P/E ratio.
Remember: P/E Ratios Don’t Consider The Balance Sheet
It’s important to note that the P/E ratio considers the market capitalization, not the enterprise value. 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 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.
How Does Time Watch Investments’s Debt Impact Its P/E Ratio?
Time Watch Investments has net cash of HK$684m. This is fairly high at 42% of its market capitalization. That might mean balance sheet strength is important to the business, but should also help push the P/E a bit higher than it would otherwise be.
The Bottom Line On Time Watch Investments’s P/E Ratio
Time Watch Investments has a P/E of 5.2. That’s below the average in the HK market, which is 8.9. Not only should the net cash position reduce risk, but the recent growth has been impressive. The relatively low P/E ratio implies the market is pessimistic.
Investors should be looking to buy stocks that the market is wrong about. 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. 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 Time Watch Investments. 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 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.
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