Should You Be Tempted To Sell Affluent Foundation Holdings Limited (HKG:1757) Because Of Its P/E Ratio?

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 13.05. That corresponds to an earnings yield of approximately 7.7%.

View our latest analysis for Affluent Foundation Holdings

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 Affluent Foundation Holdings:

P/E of 13.05 = HK$0.24 ÷ 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. 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

P/E ratios primarily reflect market expectations around earnings growth rates. When earnings grow, the 'E' increases, over time. 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.

Affluent Foundation Holdings's earnings per share fell by 20% in the last twelve months.

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

The P/E ratio indicates whether the market has higher or lower expectations of a company. The image below shows that Affluent Foundation Holdings has a higher P/E than the average (11) P/E for companies in the construction industry.

Affluent Foundation Holdings's P/E tells us that market participants think the company will perform better than its industry peers, going forward. Shareholders are clearly optimistic, but the future is always uncertain. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.

Remember: P/E Ratios Don't Consider The Balance Sheet

Don't forget that the P/E ratio considers market capitalization. That means it doesn't take debt or cash into account. 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).

Spending on growth might be good or bad a few years later, but the point is that the P/E ratio does not account for the option (or lack thereof).

Is Debt Impacting Affluent Foundation Holdings's P/E?

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 has a P/E of 13. That's higher than the average in the HK market, which is 11.4. Falling earnings per share is probably keeping traditional value investors away, but the healthy balance sheet means the company retains potential for future growth. If fails to eventuate, the current high P/E could prove to be temporary, as the share price falls.

Investors have an opportunity when market expectations about a stock are wrong. 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 Affluent Foundation Holdings. So you may wish to see this freecollection of other companies that have grown earnings strongly.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.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. Thank you for reading.