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 Wealthy Way Group Limited’s (HKG:3848) P/E ratio to inform your assessment of the investment opportunity. Wealthy Way Group has a price to earnings ratio of 31.65, based on the last twelve months. That means that at current prices, buyers pay HK$31.65 for every HK$1 in trailing yearly profits.
How Do I Calculate A Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price (in reporting currency) ÷ Earnings per Share (EPS)
Or for Wealthy Way Group:
P/E of 31.65 = CN¥5.85 (Note: this is the share price in the reporting currency, namely, CNY ) ÷ CN¥0.18 (Based on the trailing twelve months to June 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. That isn’t necessarily good or bad, but a high P/E implies relatively high expectations of what a company can achieve in the future.
How Growth Rates Impact P/E Ratios
Earnings growth rates have a big influence on P/E ratios. When earnings grow, the ‘E’ increases, over time. That means unless the share price increases, the P/E will reduce in a few years. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
Wealthy Way Group’s earnings per share fell by 36% in the last twelve months.
How Does Wealthy Way Group’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 (11.4) for companies in the diversified financial industry is lower than Wealthy Way Group’s P/E.
Its relatively high P/E ratio indicates that Wealthy Way Group shareholders think it will perform better than other companies in its industry classification. 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.
Don’t Forget: The P/E Does Not Account For Debt or Bank Deposits
The ‘Price’ in P/E reflects the market capitalization of the company. That means it doesn’t take debt or cash into account. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.
Such spending might be good or bad, overall, but the key point here is that you need to look at debt to understand the P/E ratio in context.
Is Debt Impacting Wealthy Way Group’s P/E?
Wealthy Way Group’s net debt is 70% of its market cap. This is enough debt that you’d have to make some adjustments before using the P/E ratio to compare it to a company with net cash.
The Verdict On Wealthy Way Group’s P/E Ratio
Wealthy Way Group has a P/E of 31.6. That’s significantly higher than the average in the HK market, which is 10.3. With meaningful debt and a lack of recent earnings growth, the market has high expectations that the business will earn more in the future.
Investors have an opportunity when market expectations about a stock are wrong. As value investor Benjamin Graham famously said, ‘In the short run, the market is a voting machine but in the long run, it is a weighing machine.’ We don’t have analyst forecasts, but shareholders might want to examine this detailed historical graph 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.