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 Hong Kong Finance Group Limited’s (HKG:1273) P/E ratio could help you assess the value on offer. Hong Kong Finance Group has a price to earnings ratio of 4.32, based on the last twelve months. That means that at current prices, buyers pay HK$4.32 for every HK$1 in trailing yearly profits.
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How Do I Calculate A Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Hong Kong Finance Group:
P/E of 4.32 = HK$0.56 ÷ HK$0.13 (Based on the trailing twelve months to September 2018.)
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 is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.
How Growth Rates Impact P/E Ratios
Probably the most important factor in determining what P/E a company trades on is the earnings growth. Earnings growth means that in the future the ‘E’ will be higher. That means even if the current P/E is high, it will reduce over time if the share price stays flat. Then, a lower P/E should attract more buyers, pushing the share price up.
Hong Kong Finance Group increased earnings per share by a whopping 27% last year. And it has improved its earnings per share by 1.2% per year over the last three years. So we’d generally expect it to have a relatively high P/E ratio. But earnings per share are down 2.3% per year over the last five years.
How Does Hong Kong Finance Group’s P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. The image below shows that Hong Kong Finance Group has a lower P/E than the average (14.9) P/E for companies in the mortgage industry.
This suggests that market participants think Hong Kong Finance Group will underperform other companies in its industry. Many investors like to buy stocks when the market is pessimistic about their prospects. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and selling.
Don’t Forget: The P/E Does Not Account For Debt or Bank Deposits
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. 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.
Hong Kong Finance Group’s Balance Sheet
Net debt totals a substantial 233% of Hong Kong Finance Group’s market cap. If you want to compare its P/E ratio to other companies, you must keep in mind that these debt levels would usually warrant a relatively low P/E.
The Bottom Line On Hong Kong Finance Group’s P/E Ratio
Hong Kong Finance Group has a P/E of 4.3. That’s below the average in the HK market, which is 10.5. The company may have significant debt, but EPS growth was good last year. If it continues to grow, then the current low P/E may prove to be unjustified.
When the market is wrong about a stock, it gives savvy investors an opportunity. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. We don’t have analyst forecasts, but shareholders might want to examine this detailed historical graph of earnings, revenue and cash flow.
Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at email@example.com.