Do You Know What Road King Infrastructure Limited's (HKG:1098) P/E Ratio Means?

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 Road King Infrastructure Limited's (HKG:1098) P/E ratio to inform your assessment of the investment opportunity. Based on the last twelve months, Road King Infrastructure's P/E ratio is 4.51. That corresponds to an earnings yield of approximately 22%.

See our latest analysis for Road King Infrastructure

How Do You Calculate Road King Infrastructure's P/E Ratio?

The formula for price to earnings is:

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

Or for Road King Infrastructure:

P/E of 4.51 = HK$18 ÷ HK$3.99 (Based on the trailing twelve months to December 2018.)

Is A High Price-to-Earnings 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. And in that case, the P/E ratio itself will drop rather quickly. Then, a lower P/E should attract more buyers, pushing the share price up.

In the last year, Road King Infrastructure grew EPS like Taylor Swift grew her fan base back in 2010; the 53% gain was both fast and well deserved. The sweetener is that the annual five year growth rate of 24% is also impressive. With that kind of growth rate we would generally expect a high P/E ratio.

How Does Road King Infrastructure's P/E Ratio Compare To Its Peers?

We can get an indication of market expectations by looking at the P/E ratio. We can see in the image below that the average P/E (6.8) for companies in the real estate industry is higher than Road King Infrastructure's P/E.

This suggests that market participants think Road King Infrastructure will underperform other companies in its industry. 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.

Don't Forget: The P/E Does Not Account For Debt or Bank Deposits

The 'Price' in P/E reflects the market capitalization of the company. So it won't reflect the advantage of cash, or disadvantage of debt. In theory, a company can lower its future P/E ratio by using cash or debt to invest in 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.

So What Does Road King Infrastructure's Balance Sheet Tell Us?

Road King Infrastructure's net debt is 75% of its market cap. If you want to compare its P/E ratio to other companies, you should absolutely keep in mind it has significant borrowings.

The Bottom Line On Road King Infrastructure's P/E Ratio

Road King Infrastructure's P/E is 4.5 which is below average (12.1) in the HK market. The company may have significant debt, but 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. 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.' We don't have analyst forecasts, but you could get a better understanding of its growth by checking out this more detailed historical graph of earnings, revenue and cash flow.

You might be able to find a better buy than Road King Infrastructure. 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).

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.