This article is written for those who want to get better at using price to earnings ratios (P/E ratios). To keep it practical, we’ll show how IGG Inc’s (HKG:799) P/E ratio could help you assess the value on offer. Based on the last twelve months, IGG’s P/E ratio is 10.26. That means that at current prices, buyers pay HK$10.26 for every HK$1 in trailing yearly profits.
Check out our latest analysis for IGG
How Do I Calculate IGG’s Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Share Price (in reporting currency) ÷ Earnings per Share (EPS)
Or for IGG:
P/E of 10.26 = $1.38 (Note: this is the share price in the reporting currency, namely, USD ) ÷ $0.13 (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
P/E ratios primarily reflect market expectations around earnings growth rates. When earnings grow, the ‘E’ increases, over time. 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.
It’s nice to see that IGG grew EPS by a stonking 46% in the last year. And earnings per share have improved by 41% annually, over the last five years. I’d therefore be a little surprised if its P/E ratio was not relatively high.
How Does IGG’s P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. The image below shows that IGG has a lower P/E than the average (11.6) P/E for companies in the entertainment industry.
Its relatively low P/E ratio indicates that IGG shareholders think it will struggle to do as well as other companies in its industry classification. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and selling.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
Don’t forget that the P/E ratio considers market capitalization. Thus, the metric does not reflect cash or debt held by the company. 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.
Is Debt Impacting IGG’s P/E?
The extra options and safety that comes with IGG’s US$283m net cash position means that it deserves a higher P/E than it would if it had a lot of net debt.
The Verdict On IGG’s P/E Ratio
IGG’s P/E is 10.3 which is about average (10.2) in the HK market. The balance sheet is healthy, and recent EPS growth impressive, but the P/E implies some caution from the market. Since analysts are predicting growth will continue, one might expect to see a higher P/E so it may be worth looking closer.
Investors should be looking to buy stocks that the market is wrong about. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. 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.
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 editorial-team@simplywallst.com.