This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We’ll look at KFM Kingdom Holdings Limited’s (HKG:3816) P/E ratio and reflect on what it tells us about the company’s share price. Based on the last twelve months, KFM Kingdom Holdings’s P/E ratio is 6.23. In other words, at today’s prices, investors are paying HK$6.23 for every HK$1 in prior year profit.
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 KFM Kingdom Holdings:
P/E of 6.23 = HK$0.41 ÷ HK$0.067 (Based on the year to September 2018.)
Is A High P/E 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 a good or a bad thing on its own, but a high P/E means that buyers have a higher opinion of the business’s prospects, relative to stocks with a lower P/E.
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 even if the current P/E is high, it will reduce over time if the share price stays flat. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
KFM Kingdom Holdings increased earnings per share by a whopping 193% last year. And earnings per share have improved by 98% annually, over the last three years. With that performance, I would expect it to have an above average P/E ratio. In contrast, EPS has decreased by 18%, annually, over 5 years.
How Does KFM Kingdom Holdings’s P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. The image below shows that KFM Kingdom Holdings has a lower P/E than the average (9.4) P/E for companies in the machinery industry.
This suggests that market participants think KFM Kingdom Holdings will underperform other companies in its industry. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.
Remember: P/E Ratios Don’t Consider The Balance Sheet
The ‘Price’ in P/E reflects the market capitalization of the company. 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 taking on debt (or spending its remaining cash).
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.
Is Debt Impacting KFM Kingdom Holdings’s P/E?
KFM Kingdom Holdings has net debt worth 15% of its market capitalization. This could bring some additional risk, and reduce the number of investment options for management; worth remembering if you compare its P/E to businesses without debt.
The Verdict On KFM Kingdom Holdings’s P/E Ratio
KFM Kingdom Holdings’s P/E is 6.2 which is below average (10.3) in the HK market. The company hasn’t stretched its balance sheet, and earnings growth was good last year. The low P/E ratio suggests current market expectations are muted, implying these levels of growth will not continue.
Investors have an opportunity when market expectations about a stock are wrong. 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 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 KFM Kingdom 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 email@example.com.