Should We Worry About AKM Industrial Company Limited's (HKG:1639) P/E Ratio?

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The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We'll show how you can use AKM Industrial Company Limited's (HKG:1639) P/E ratio to inform your assessment of the investment opportunity. Based on the last twelve months, AKM Industrial's P/E ratio is 27.95. That means that at current prices, buyers pay HK$27.95 for every HK$1 in trailing yearly profits.

View our latest analysis for AKM Industrial

How Do You Calculate A P/E Ratio?

The formula for P/E is:

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

Or for AKM Industrial:

P/E of 27.95 = HK$1.28 ÷ HK$0.046 (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 necessarily good or bad, but a high P/E implies relatively high expectations of what a company can achieve in the future.

How Growth Rates Impact P/E Ratios

Earnings growth rates have a big influence on P/E ratios. Earnings growth means that in the future the 'E' will be higher. That means even if the current P/E is high, it will reduce over time if the share price stays flat. Then, a lower P/E should attract more buyers, pushing the share price up.

AKM Industrial saw earnings per share decrease by 31% last year. But over the longer term (3 years), earnings per share have increased by 526%. And it has shrunk its earnings per share by 3.8% per year over the last five years. This growth rate might warrant a below average P/E ratio.

Does AKM Industrial Have A Relatively High Or Low P/E For Its Industry?

We can get an indication of market expectations by looking at the P/E ratio. As you can see below, AKM Industrial has a higher P/E than the average company (11.9) in the electronic industry.

AKM Industrial's P/E tells us that market participants think the company will perform better than its industry peers, going forward. Clearly the market expects growth, but it isn't guaranteed. So further research is always essential. 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. In other words, it does not consider any debt or cash that the company may have on the balance sheet. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.

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 AKM Industrial's Debt Impact Its P/E Ratio?

Since AKM Industrial holds net cash of HK$153m, it can spend on growth, justifying a higher P/E ratio than otherwise.

The Verdict On AKM Industrial's P/E Ratio

AKM Industrial's P/E is 28 which is above average (11.7) in the HK market. Falling earnings per share is probably keeping traditional value investors away, but the healthy balance sheet means the company retains potential for future growth. If fails to eventuate, the current high P/E could prove to be temporary, as the share price falls.

Investors should be looking to buy stocks that the market is wrong about. People often underestimate remarkable growth -- so investors can make money when fast growth is not fully appreciated. 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 AKM Industrial. 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.