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Is Affluent Foundation Holdings Limited’s (HKG:1757) High P/E Ratio A Problem For Investors?

This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We’ll look at Affluent Foundation Holdings Limited’s (HKG:1757) P/E ratio and reflect on what it tells us about the company’s share price. Based on the last twelve months, Affluent Foundation Holdings’s P/E ratio is 14.76. That means that at current prices, buyers pay HK\$14.76 for every HK\$1 in trailing yearly profits.

How Do You Calculate A P/E Ratio?

The formula for P/E is:

Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)

Or for Affluent Foundation Holdings:

P/E of 14.76 = HK\$0.28 ÷ HK\$0.019 (Based on the year to September 2018.)

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. 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 Growth Rates Impact P/E Ratios

P/E ratios primarily reflect market expectations around earnings growth rates. 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.

Affluent Foundation Holdings shrunk earnings per share by 20% over the last year.

How Does Affluent Foundation Holdings’s P/E Ratio Compare To Its Peers?

We can get an indication of market expectations by looking at the P/E ratio. You can see in the image below that the average P/E (11.2) for companies in the construction industry is lower than Affluent Foundation Holdings’s P/E.

Its relatively high P/E ratio indicates that Affluent Foundation Holdings shareholders think it will perform better than other companies in its industry classification. Clearly the market expects growth, but it isn’t guaranteed. So investors should delve deeper. I like to check if company insiders have been buying or selling.

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. Thus, the metric does not reflect cash or debt held by the company. 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.

How Does Affluent Foundation Holdings’s Debt Impact Its P/E Ratio?

Since Affluent Foundation Holdings holds net cash of HK\$25m, it can spend on growth, justifying a higher P/E ratio than otherwise.

The Bottom Line On Affluent Foundation Holdings’s P/E Ratio

Affluent Foundation Holdings trades on a P/E ratio of 14.8, which is above the HK market average of 10.7. The recent drop in earnings per share would make some investors cautious, but the relatively strong balance sheet will allow the company time to invest in growth. Clearly, the high P/E indicates shareholders think it will!

Investors should be looking to buy stocks that the market is wrong about. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. We don’t have analyst forecasts, but you might want to assess this data-rich visualization of earnings, revenue and cash flow.

You might be able to find a better buy than Affluent Foundation Holdings. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).

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 editorial-team@simplywallst.com.