This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We’ll show how you can use Hengan International Group Company Limited’s (HKG:1044) P/E ratio to inform your assessment of the investment opportunity. Based on the last twelve months, Hengan International Group’s P/E ratio is 15.26. That is equivalent to an earnings yield of about 6.6%.
How Do I Calculate Hengan International Group’s 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 Hengan International Group:
P/E of 15.26 = CN¥49.21 (Note: this is the share price in the reporting currency, namely, CNY ) ÷ CN¥3.22 (Based on the trailing twelve months to June 2018.)
Is A High P/E 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 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
P/E ratios primarily reflect market expectations around earnings growth rates. That’s because companies that grow earnings per share quickly will rapidly increase the ‘E’ in the equation. That means even if the current P/E is high, it will reduce over time if the share price stays flat. A lower P/E should indicate the stock is cheap relative to others — and that may attract buyers.
Hengan International Group’s earnings per share grew by -9.7% in the last twelve months. And its annual EPS growth rate over 5 years is 6.3%.
How Does Hengan International Group’s P/E Ratio Compare To Its Peers?
The P/E ratio indicates whether the market has higher or lower expectations of a company. As you can see below, Hengan International Group has a higher P/E than the average company (14) in the personal products industry.
Its relatively high P/E ratio indicates that Hengan International Group shareholders think it will perform better than other companies in its industry classification. Clearly the market expects growth, but it isn’t guaranteed. 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
Don’t forget that the P/E ratio considers market capitalization. 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.
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).
Hengan International Group’s Balance Sheet
Hengan International Group has net debt worth just 0.4% of its market capitalization. It would probably trade on a higher P/E ratio if it had a lot of cash, but I doubt it is having a big impact.
The Verdict On Hengan International Group’s P/E Ratio
Hengan International Group trades on a P/E ratio of 15.3, which is above the HK market average of 10.4. With debt at prudent levels and improving earnings, it’s fair to say the market expects steady progress 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.’ So this free visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.
But note: Hengan International Group may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio 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 email@example.com.