The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We’ll show how you can use Yangtzekiang Garment Limited’s (HKG:294) P/E ratio to inform your assessment of the investment opportunity. Yangtzekiang Garment has a price to earnings ratio of 15.52, based on the last twelve months. That is equivalent to an earnings yield of about 6.4%.
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 Yangtzekiang Garment:
P/E of 15.52 = HK$3 ÷ HK$0.19 (Based on the trailing twelve months 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 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
Probably the most important factor in determining what P/E a company trades on is the earnings growth. Earnings growth means that in the future the ‘E’ will be higher. 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.
Yangtzekiang Garment increased earnings per share by a whopping 111% last year. And earnings per share have improved by 15% annually, over the last five years. I’d therefore be a little surprised if its P/E ratio was not relatively high.
How Does Yangtzekiang Garment’s P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. As you can see below, Yangtzekiang Garment has a higher P/E than the average company (10.1) in the luxury industry.
That means that the market expects Yangtzekiang Garment will outperform other companies in its industry. Shareholders are clearly optimistic, but the future is always uncertain. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.
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).
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).
Yangtzekiang Garment’s Balance Sheet
Yangtzekiang Garment has net cash of HK$282m. That should lead to a higher P/E than if it did have debt, because its strong balance sheets gives it more options.
The Verdict On Yangtzekiang Garment’s P/E Ratio
Yangtzekiang Garment trades on a P/E ratio of 15.5, which is above the HK market average of 10.5. Its net cash position supports a higher P/E ratio, as does its solid recent earnings growth. So it does not seem strange that the P/E is above average.
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. Although we don’t have analyst forecasts, you might want to assess this data-rich visualization of earnings, revenue and cash flow.
Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.
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 firstname.lastname@example.org.