Is China Display Optoelectronics Technology Holdings Limited (HKG:334) A Sell At Its Current PE Ratio?

334’s current PE is 10.03x based on past earnings, quite similar to the Tech’s average of 10.03x. But should this fair multiple be the final verdict of 334’s fair valuation? No. This is because multiples like PE tend to overlook key company-specific factors such as future growth and capital structure. In this article, I am going to take you through some key things to consider in order to identify which multiple is the most relevant for 334. Let’s take a look below.

Is 334 making any money?

PE is only used when a company is profitable, such as 334. This is because companies that are unprofitable or have recently become loss making cannot be valued using price-to-earnings since there are no earnings. Other useful measures can be employed to evaluate companies in this situation, such as price-to-free-cash-flow or price-to-sales where it is suitable. In the past, 334 has always maintained its profitability. As earnings forecasts indicate the positive trend will continue, the PE multiple can be an acceptable tool to assess the 334’s value, but let’s see if there is a better alternative.

SEHK:334 Future Profit June 24th 18
SEHK:334 Future Profit June 24th 18

Does 334 owe a lot of money?

Generally, debt should be below 40% of equity. Given that ’s debt-to-equity ratio is currently 76.97%, there’s room for improvement. The current ratio can be interpreted as for every HK$1 a shareholder owns, it owes HK$0.77 to creditors. This can be risky, given that in the event of bankruptcy, these debtors receive the first claim on the assets of the company.

SEHK:334 Historical Debt June 24th 18
SEHK:334 Historical Debt June 24th 18
So, what does debt have to do with valuation? The company’s share price theoretically reflects the value of 334’s equity only, but its important to account for debt, because debt represents a liability to the owner, and it impacts the earnings capacity and risk profile of the company. This can be done using enterprise value (EV) instead of share price. EV adds in debt and subtracts cash in order to recognise both sources of funding and is commonly used in the EV/EBITDA multiple.

334’s EV/EBITDA = HK$1.20b / HK$0 = 7.01x

Comparing 334’s multiple to the 7.01x for the industry suggests the company is undervalued, in contrast to the price-to-earnings multiple which suggested the company was trading at a reasonable price.

Will 334 experience high growth?

If analyst predictions are right, the company’s earnings are forecasted to grow by 18.90% every year for the next 5 years, which is relatively robust. The issue with using current earnings in the denominator of a multiple is that it doesn’t reflect this expected growth, which is a setback for trailing multiples. You should pay for what you’re going to get, not what’s already happened. To shift our analysis to focus on the future, we will use a forward figure for EBITDA based off analyst forecasts for the year ahead.

334’s forward EV/EBITDA = HK$1.20b /HK$202.50m = 5.91x

The 6.56x average multiple for the industry suggests that 334 is valued fairly relative to its peers. in contrast to the trailing enterprise-value-to-EBITDA multiple which suggested the company was selling at a premium to fair value.

Next Steps:

Basing your investment decision based on relative valuation metrics alone is certainly no sufficient. There are many important factors I have not taken into account in this article. If you have not done so already, I highly recommend you to complete your research by taking a look at the following:

  1. Future Outlook: What are well-informed industry analysts predicting for ’s future growth? Take a look at our free research report of analyst consensus for ’s outlook.
  2. Financial Health: Is ’s operations financially sustainable? Balance sheets can be hard to analyze, which is why we’ve done it for you. Check out our financial health checks here.
  3. Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.