This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We’ll apply a basic P/E ratio analysis to Lung Kee (Bermuda) Holdings Limited’s (HKG:255), to help you decide if the stock is worth further research. Lung Kee (Bermuda) Holdings has a P/E ratio of 12.45, based on the last twelve months. That means that at current prices, buyers pay HK$12.45 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 Lung Kee (Bermuda) Holdings:
P/E of 12.45 = HK$3.36 ÷ HK$0.27 (Based on the year to December 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 isn’t necessarily good or bad, but a high P/E implies relatively high expectations of what a company can achieve in the future.
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 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.
Lung Kee (Bermuda) Holdings saw earnings per share decrease by 39% last year. But it has grown its earnings per share by 3.3% per year over the last five years.
How Does Lung Kee (Bermuda) 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. You can see in the image below that the average P/E (9) for companies in the machinery industry is lower than Lung Kee (Bermuda) Holdings’s P/E.
Lung Kee (Bermuda) 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 delve deeper. I like to check if company insiders have been buying or selling.
Don’t Forget: The P/E Does Not Account For Debt or Bank Deposits
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. Thus, the metric does not reflect cash or debt held by the company. Theoretically, a business can improve its earnings (and produce a lower P/E in the future) by investing in growth. That means taking on debt (or spending its cash).
While growth expenditure doesn’t always pay off, the point is that it is a good option to have; but one that the P/E ratio ignores.
So What Does Lung Kee (Bermuda) Holdings’s Balance Sheet Tell Us?
With net cash of HK$728m, Lung Kee (Bermuda) Holdings has a very strong balance sheet, which may be important for its business. Having said that, at 34% of its market capitalization the cash hoard would contribute towards a higher P/E ratio.
The Verdict On Lung Kee (Bermuda) Holdings’s P/E Ratio
Lung Kee (Bermuda) Holdings trades on a P/E ratio of 12.4, which is above the HK market average of 11.2. 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.
When the market is wrong about a stock, it gives savvy investors an opportunity. People often underestimate remarkable growth — so investors can make money when fast growth is not fully appreciated. Although we don’t have analyst forecasts, shareholders might want to examine this detailed historical graph of earnings, revenue and cash flow.
You might be able to find a better buy than Lung Kee (Bermuda) 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).
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.