The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). To keep it practical, we'll show how Telecom Service One Holdings Limited's (HKG:3997) P/E ratio could help you assess the value on offer. Telecom Service One Holdings has a price to earnings ratio of 16.73, based on the last twelve months. That is equivalent to an earnings yield of about 6.0%.
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Telecom Service One Holdings:
P/E of 16.73 = HK$3.3 ÷ HK$0.20 (Based on the trailing twelve months to March 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
P/E ratios primarily reflect market expectations around earnings growth rates. That's because companies that grow earnings per share quickly will rapidly increase the 'E' in the equation. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
Telecom Service One Holdings saw earnings per share improve by -5.9% last year. And its annual EPS growth rate over 5 years is 16%.
How Does Telecom Service One 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 (14.7) for companies in the commercial services industry is lower than Telecom Service One Holdings's P/E.
SEHK:3997 PE PEG Gauge October 24th 18
Its relatively high P/E ratio indicates that Telecom Service One Holdings shareholders think it will perform better than other companies in its industry classification. The market is optimistic about the future, but that doesn't guarantee future growth. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. 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 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.
How Does Telecom Service One Holdings's Debt Impact Its P/E Ratio?
Since Telecom Service One Holdings holds net cash of HK$83m, it can spend on growth, justifying a higher P/E ratio than otherwise.
The Bottom Line On Telecom Service One Holdings's P/E Ratio
Telecom Service One Holdings has a P/E of 16.7. That's higher than the average in the HK market, which is 10.9. Earnings improved over the last year. Also positive, the relatively strong balance sheet will allow for investment in growth -- and the P/E indicates shareholders that will happen!
When the market is wrong about a stock, it gives savvy investors an opportunity. 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 could get a better understanding of its growth by checking out this more detailed historical graph of earnings, revenue and cash flow.
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.
Simply Wall St analyst Simply Wall St and Simply Wall St have no position in any of the companies mentioned. This article is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
About SEHK:3997
Telecom Service One Holdings
An investment holding company, engages in the provision of repair and refurbishment services for mobile phones and other personal electronic products in Hong Kong.
