Is DaChan Food (Asia) Limited’s (HKG:3999) High P/E Ratio A Problem For Investors?

Today, we’ll introduce the concept of the P/E ratio for those who are learning about investing. To keep it practical, we’ll show how DaChan Food (Asia) Limited’s (HKG:3999) P/E ratio could help you assess the value on offer. Based on the last twelve months, DaChan Food (Asia)’s P/E ratio is 27.76. That is equivalent to an earnings yield of about 3.6%.

View our latest analysis for DaChan Food (Asia)

How Do I Calculate A Price To Earnings Ratio?

The formula for P/E is:

Price to Earnings Ratio = Price per Share (in the reporting currency) ÷ Earnings per Share (EPS)

Or for DaChan Food (Asia):

P/E of 27.76 = CN¥0.36 (Note: this is the share price in the reporting currency, namely, CNY ) ÷ CN¥0.013 (Based on the trailing twelve months to December 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

Probably the most important factor in determining what P/E a company trades on is the earnings growth. If earnings are growing quickly, then the ‘E’ in the equation will increase faster than it would otherwise. And in that case, the P/E ratio itself will drop rather quickly. A lower P/E should indicate the stock is cheap relative to others — and that may attract buyers.

DaChan Food (Asia) shrunk earnings per share by 55% over the last year.

How Does DaChan Food (Asia)’s P/E Ratio Compare To Its Peers?

The P/E ratio essentially measures market expectations of a company. As you can see below, DaChan Food (Asia) has a higher P/E than the average company (16.8) in the food industry.

SEHK:3999 Price Estimation Relative to Market, April 15th 2019
SEHK:3999 Price Estimation Relative to Market, April 15th 2019

That means that the market expects DaChan Food (Asia) will outperform other companies in its industry. Clearly the market expects growth, but it isn’t guaranteed. So further research is always essential. I often monitor director buying and selling.

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. So it won’t reflect the advantage of cash, or disadvantage of debt. The exact same company would hypothetically deserve a higher P/E ratio if it had a strong balance sheet, than if it had a weak one with lots of debt, because a cashed up company can spend on growth.

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.

DaChan Food (Asia)’s Balance Sheet

DaChan Food (Asia) has net debt worth a very significant 177% of its market capitalization. This level of debt justifies a relatively low P/E, so remain cognizant of the debt, if you’re comparing it to other stocks.

The Verdict On DaChan Food (Asia)’s P/E Ratio

DaChan Food (Asia)’s P/E is 27.8 which is above average (12.1) in the HK market. With relatively high debt, and no earnings per share growth over twelve months, it’s safe to say the market believes the company will improve its earnings growth 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.’ Although we don’t have analyst forecasts, shareholders might want to examine this detailed historical graph of earnings, revenue and cash flow.

You might be able to find a better buy than DaChan Food (Asia). 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).

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 editorial-team@simplywallst.com. 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.