Despite Its High P/E Ratio, Is EVA Precision Industrial Holdings Limited (HKG:838) Still Undervalued?

Today, we’ll introduce the concept of the P/E ratio for those who are learning about investing. We’ll look at EVA Precision Industrial Holdings Limited’s (HKG:838) P/E ratio and reflect on what it tells us about the company’s share price. Based on the last twelve months, EVA Precision Industrial Holdings’s P/E ratio is 15.99. That corresponds to an earnings yield of approximately 6.3%.

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View our latest analysis for EVA Precision Industrial Holdings

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 EVA Precision Industrial Holdings:

P/E of 15.99 = HK$0.76 ÷ HK$0.048 (Based on the year to December 2018.)

Is A High P/E Ratio Good?

A higher P/E ratio implies that investors pay a higher price for the earning power of the business. 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

Companies that shrink earnings per share quickly will rapidly decrease the ‘E’ in the equation. Therefore, even if you pay a low multiple of earnings now, that multiple will become higher in the future. A higher P/E should indicate the stock is expensive relative to others — and that may encourage shareholders to sell.

EVA Precision Industrial Holdings shrunk earnings per share by 36% over the last year. But EPS is up 7.6% over the last 5 years. And it has shrunk its earnings per share by 25% per year over the last three years. This might lead to low expectations.

Does EVA Precision Industrial Holdings Have A Relatively High Or Low P/E For Its Industry?

One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. The image below shows that EVA Precision Industrial Holdings has a higher P/E than the average (8.8) P/E for companies in the machinery industry.

SEHK:838 Price Estimation Relative to Market, May 15th 2019
SEHK:838 Price Estimation Relative to Market, May 15th 2019

Its relatively high P/E ratio indicates that EVA Precision Industrial Holdings shareholders think it will perform better than other companies in its industry classification. Shareholders are clearly optimistic, but the future is always uncertain. So further research is always essential. I often monitor director buying and selling.

A Limitation: P/E Ratios Ignore Debt and Cash In The Bank

The ‘Price’ in P/E reflects the market capitalization of the company. 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 investing in growth. That means taking on debt (or spending its 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 EVA Precision Industrial Holdings’s P/E?

EVA Precision Industrial Holdings’s net debt is 51% of its market cap. This is a reasonably significant level of debt — all else being equal you’d expect a much lower P/E than if it had net cash.

The Bottom Line On EVA Precision Industrial Holdings’s P/E Ratio

EVA Precision Industrial Holdings has a P/E of 16. That’s higher than the average in the HK market, which is 11.3. With relatively high debt, and no earnings per share growth over twelve months, it’s safe to say the market believes the company will improve its earnings growth in the future.

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. Although we don’t have analyst forecasts, you could get a better understanding of its growth by checking out this more detailed historical graph of earnings, revenue and cash flow.

Of course you might be able to find a better stock than EVA Precision Industrial Holdings. So you may wish to see this free collection 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.