This article is written for those who want to get better at using price to earnings ratios (P/E ratios). To keep it practical, we’ll show how Dragon Crown Group Holdings Limited’s (HKG:935) P/E ratio could help you assess the value on offer. Looking at earnings over the last twelve months, Dragon Crown Group Holdings has a P/E ratio of 12.77. That means that at current prices, buyers pay HK$12.77 for every HK$1 in trailing yearly profits.
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How Do I Calculate A Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Dragon Crown Group Holdings:
P/E of 12.77 = HK$0.70 ÷ HK$0.055 (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. All else being equal, it’s better to pay a low price — but as Warren Buffett said, ‘It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.’
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. Then, a higher P/E might scare off shareholders, pushing the share price down.
Dragon Crown Group Holdings increased earnings per share by a whopping 33% last year. In contrast, EPS has decreased by 10%, annually, over 5 years.
How Does Dragon Crown Group 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 (13.6) for companies in the commercial services industry is roughly the same as Dragon Crown Group Holdings’s P/E.
That indicates that the market expects Dragon Crown Group Holdings will perform roughly in line with other companies in its industry. If the company has better than average prospects, then the market might be underestimating it. I inform my view byby checking management tenure and remuneration, among other things.
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 investing in growth. That means taking on debt (or spending its 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.
So What Does Dragon Crown Group Holdings’s Balance Sheet Tell Us?
Dragon Crown Group Holdings has net cash of HK$25m. That should lead to a higher P/E than if it did have debt, because its strong balance sheets gives it more options.
The Bottom Line On Dragon Crown Group Holdings’s P/E Ratio
Dragon Crown Group Holdings’s P/E is 12.8 which is above average (11.1) in the HK market. Its net cash position is the cherry on top of its superb EPS growth. So based on this analysis we’d expect Dragon Crown Group Holdings to have a high P/E ratio.
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 Dragon Crown Group 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 firstname.lastname@example.org. 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.