The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We’ll look at G.A. Holdings Limited’s (HKG:8126) P/E ratio and reflect on what it tells us about the company’s share price. G.A. Holdings has a P/E ratio of 9.76, based on the last twelve months. That is equivalent to an earnings yield of about 10%.
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 G.A. Holdings:
P/E of 9.76 = HK$0.47 ÷ HK$0.049 (Based on the year to September 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. All else being equal, it’s better to pay a low price — but as Warren Buffett said, ‘It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.’
How Growth Rates Impact P/E Ratios
Companies that shrink earnings per share quickly will rapidly decrease the ‘E’ in the equation. That means unless the share price falls, the P/E will increase in a few years. A higher P/E should indicate the stock is expensive relative to others — and that may encourage shareholders to sell.
G.A. Holdings shrunk earnings per share by 63% over the last year. And over the longer term (5 years) earnings per share have decreased 14% annually. This could justify a pessimistic P/E.
How Does G.A. Holdings’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 G.A. Holdings has a lower P/E than the average (11.5) in the retail distributors industry classification.
Its relatively low P/E ratio indicates that G.A. Holdings shareholders think it will struggle to do as well as other companies in its industry classification. Since the market seems unimpressed with G.A. Holdings, 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.
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. In other words, it does not consider any debt or cash that the company may have on the balance sheet. 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 G.A. Holdings’s Debt Impact Its P/E Ratio?
G.A. Holdings has net debt worth a very significant 200% of its market capitalization. If you want to compare its P/E ratio to other companies, you must keep in mind that these debt levels would usually warrant a relatively low P/E.
The Verdict On G.A. Holdings’s P/E Ratio
G.A. Holdings’s P/E is 9.8 which is about average (10.3) in the HK market. With relatively high debt, and no earnings per share growth over twelve months, the P/E suggests that many have an expectation that company will find some growth.
Investors should be looking to buy stocks that the market is wrong about. 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 shareholders might want to examine this detailed historical graph of earnings, revenue and cash flow.
You might be able to find a better buy than G.A. Holdings. If you want a selection of possible winners, check out this free list 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 email@example.com.