Is Lee and Man Paper Manufacturing Limited's (HKG:2314) P/E Ratio Really That Good?

This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We'll look at Lee and Man Paper Manufacturing Limited's (HKG:2314) P/E ratio and reflect on what it tells us about the company's share price. Lee and Man Paper Manufacturing has a P/E ratio of 5.06, based on the last twelve months. That means that at current prices, buyers pay HK$5.06 for every HK$1 in trailing yearly profits.

View our latest analysis for Lee and Man Paper Manufacturing

How Do You Calculate Lee and Man Paper Manufacturing's P/E Ratio?

The formula for price to earnings is:

Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)

Or for Lee and Man Paper Manufacturing:

P/E of 5.06 = HK$6.56 ÷ HK$1.3 (Based on the trailing twelve months to June 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 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

Earnings growth rates have a big influence on P/E ratios. That's because companies that grow earnings per share quickly will rapidly increase the 'E' in the equation. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.

Notably, Lee and Man Paper Manufacturing grew EPS by a whopping 63% in the last year. And its annual EPS growth rate over 5 years is 29%. I'd therefore be a little surprised if its P/E ratio was not relatively high.

How Does Lee and Man Paper Manufacturing's P/E Ratio Compare To Its Peers?

The P/E ratio indicates whether the market has higher or lower expectations of a company. If you look at the image below, you can see Lee and Man Paper Manufacturing has a lower P/E than the average (11.3) in the forestry industry classification.

Lee and Man Paper Manufacturing's P/E tells us that market participants think it will not fare as well as its peers in the same industry. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. You should delve deeper. I like to check if company insiders have been buying or selling.

A Limitation: P/E Ratios Ignore Debt and Cash In The Bank

The 'Price' in P/E reflects the market capitalization of the company. That means it doesn't take debt or cash into account. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.

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.

How Does Lee and Man Paper Manufacturing's Debt Impact Its P/E Ratio?

Lee and Man Paper Manufacturing's net debt is 50% 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 Bottom Line On Lee and Man Paper Manufacturing's P/E Ratio

Lee and Man Paper Manufacturing trades on a P/E ratio of 5.1, which is below the HK market average of 10.3. The company does have a little debt, and EPS growth was good last year. The low P/E ratio suggests current market expectations are muted, implying these levels of growth will not continue.

Investors have an opportunity when market expectations about a stock are wrong. If the reality for a company is not as bad as the P/E ratio indicates, then the share price should increase as the market realizes this. So this freereport on the analyst consensus forecasts could help you make a master move on this stock.

You might be able to find a better buy than Lee and Man Paper Manufacturing. If you want a selection of possible winners, check out this freelist of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).

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 editorial-team@simplywallst.com.

Simply Wall St analyst Simply Wall St and Simply Wall St have no position in any of the companies mentioned. This article is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.