Read This Before You Buy K W Nelson Interior Design and Contracting Group Limited (HKG:8411) Because Of Its P/E Ratio

This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We’ll show how you can use K W Nelson Interior Design and Contracting Group Limited’s (HKG:8411) P/E ratio to inform your assessment of the investment opportunity. Based on the last twelve months, K W Nelson Interior Design and Contracting Group’s P/E ratio is 6.01. That corresponds to an earnings yield of approximately 17%.

View our latest analysis for K W Nelson Interior Design and Contracting Group

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 K W Nelson Interior Design and Contracting Group:

P/E of 6.01 = HK$0.21 ÷ HK$0.034 (Based on the year to September 2018.)

Is A High Price-to-Earnings Ratio Good?

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

Probably the most important factor in determining what P/E a company trades on is the earnings growth. That’s because companies that grow earnings per share quickly will rapidly increase the ‘E’ in the equation. That means unless the share price increases, the P/E will reduce in a few years. Then, a lower P/E should attract more buyers, pushing the share price up.

Notably, K W Nelson Interior Design and Contracting Group grew EPS by a whopping 182% in the last year. And earnings per share have improved by 54% annually, over the last three years. So we’d generally expect it to have a relatively high P/E ratio.

How Does K W Nelson Interior Design and Contracting Group’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 K W Nelson Interior Design and Contracting Group has a lower P/E than the average (13) P/E for companies in the professional services industry.

SEHK:8411 PE PEG Gauge December 6th 18
SEHK:8411 PE PEG Gauge December 6th 18

This suggests that market participants think K W Nelson Interior Design and Contracting Group will underperform other companies in its industry. Since the market seems unimpressed with K W Nelson Interior Design and Contracting Group, it’s quite possible it could surprise on the upside. You should delve deeper. I like to check if company insiders have been buying or 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. 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.

How Does K W Nelson Interior Design and Contracting Group’s Debt Impact Its P/E Ratio?

The extra options and safety that comes with K W Nelson Interior Design and Contracting Group’s HK$86m net cash position means that it deserves a higher P/E than it would if it had a lot of net debt.

The Bottom Line On K W Nelson Interior Design and Contracting Group’s P/E Ratio

K W Nelson Interior Design and Contracting Group trades on a P/E ratio of 6, which is below the HK market average of 10.7. It grew its EPS nicely over the last year, and the healthy balance sheet implies there is more potential for growth. One might conclude that the market is a bit pessimistic, given the low P/E ratio.

When the market is wrong about a stock, it gives savvy investors an opportunity. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. 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.

You might be able to find a better buy than K W Nelson Interior Design and Contracting Group. 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 editorial-team@simplywallst.com.