The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We’ll show how you can use Milestone Builder Holdings Limited’s (HKG:1667) P/E ratio to inform your assessment of the investment opportunity. Milestone Builder Holdings has a price to earnings ratio of 14.51, based on the last twelve months. In other words, at today’s prices, investors are paying HK$14.51 for every HK$1 in prior year profit.
How Do I Calculate A Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Milestone Builder Holdings:
P/E of 14.51 = HK$0.23 ÷ HK$0.016 (Based on the trailing twelve months to September 2018.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio means that investors are paying a higher price for each HK$1 of company 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 Growth Rates Impact P/E Ratios
Earnings growth rates have a big influence on P/E ratios. That’s because companies that grow earnings per share quickly will rapidly increase the ‘E’ in the equation. That means unless the share price increases, the P/E will reduce in a few years. Then, a lower P/E should attract more buyers, pushing the share price up.
It’s great to see that Milestone Builder Holdings grew EPS by 23% in the last year.
How Does Milestone Builder Holdings’s P/E Ratio Compare To Its Peers?
We can get an indication of market expectations by looking at the P/E ratio. The image below shows that Milestone Builder Holdings has a higher P/E than the average (10.9) P/E for companies in the construction industry.
Its relatively high P/E ratio indicates that Milestone Builder Holdings shareholders think it will perform better than other companies in its industry classification. The market is optimistic about the future, but that doesn’t guarantee future growth. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
It’s important to note that the P/E ratio considers the market capitalization, not the enterprise value. In other words, it does not consider any debt or cash that the company may have on the balance sheet. Theoretically, a business can improve its earnings (and produce a lower P/E in the future), by taking on debt (or spending its remaining cash).
Such spending might be good or bad, overall, but the key point here is that you need to look at debt to understand the P/E ratio in context.
Milestone Builder Holdings’s Balance Sheet
Milestone Builder Holdings’s net debt is 54% of its market cap. This is enough debt that you’d have to make some adjustments before using the P/E ratio to compare it to a company with net cash.
The Bottom Line On Milestone Builder Holdings’s P/E Ratio
Milestone Builder Holdings has a P/E of 14.5. That’s higher than the average in the HK market, which is 10.6. While the meaningful level of debt does limit its options, it has achieved solid growth over the last year. It seems the market believes growth will continue, judging by the P/E ratio.
Investors should be looking to buy stocks that the market is wrong about. 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.’ 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 be able to find a better stock than Milestone Builder Holdings. So you may wish to see this free collection of other companies that have grown earnings strongly.
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.