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The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). To keep it practical, we’ll show how Modern Dental Group Limited’s (HKG:3600) P/E ratio could help you assess the value on offer. Based on the last twelve months, Modern Dental Group’s P/E ratio is 14.48. That means that at current prices, buyers pay HK$14.48 for every HK$1 in trailing yearly profits.
How Do You Calculate A P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Modern Dental Group:
P/E of 14.48 = HK$1.24 ÷ HK$0.086 (Based on the year to December 2018.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio means that buyers have to pay a higher price for each HK$1 the company has earned over the last year. 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
When earnings fall, the ‘E’ decreases, over time. That means unless the share price falls, the P/E will increase in a few years. Then, a higher P/E might scare off shareholders, pushing the share price down.
Modern Dental Group’s earnings per share fell by 45% in the last twelve months. And it has shrunk its earnings per share by 9.3% per year over the last five years. This growth rate might warrant a below average P/E ratio.
Does Modern Dental Group Have A Relatively High Or Low P/E For Its Industry?
The P/E ratio essentially measures market expectations of a company. The image below shows that Modern Dental Group has a lower P/E than the average (16.3) P/E for companies in the medical equipment industry.
Its relatively low P/E ratio indicates that Modern Dental Group shareholders think it will struggle to do as well as other companies in its industry classification. Since the market seems unimpressed with Modern Dental 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.
Remember: P/E Ratios Don’t Consider The Balance Sheet
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. 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).
While growth expenditure doesn’t always pay off, the point is that it is a good option to have; but one that the P/E ratio ignores.
So What Does Modern Dental Group’s Balance Sheet Tell Us?
Net debt is 32% of Modern Dental Group’s market cap. While it’s worth keeping this in mind, it isn’t a worry.
The Bottom Line On Modern Dental Group’s P/E Ratio
Modern Dental Group trades on a P/E ratio of 14.5, which is above the HK market average of 10.7. With some debt but no EPS growth last year, the market has high expectations of future profits.
Investors have an opportunity when market expectations about a stock are wrong. 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 be able to find a better stock than Modern Dental Group. 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.