This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We'll look at Changhong Jiahua Holdings Limited's (HKG:8016) P/E ratio and reflect on what it tells us about the company's share price. Looking at earnings over the last twelve months, Changhong Jiahua Holdings has a P/E ratio of 6.25. That corresponds to an earnings yield of approximately 16.0%.
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 Changhong Jiahua Holdings:
P/E of 6.25 = HK$0.70 ÷ HK$0.11 (Based on the trailing twelve months to September 2019.)
Is A High P/E Ratio Good?
A higher P/E ratio implies that investors pay a higher price for the earning power of the business. 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 Does Changhong Jiahua Holdings'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 (9.2) for companies in the electronic industry is higher than Changhong Jiahua Holdings's P/E.
Its relatively low P/E ratio indicates that Changhong Jiahua Holdings shareholders think it will struggle to do as well as other companies in its industry classification.
How Growth Rates Impact P/E Ratios
Probably the most important factor in determining what P/E a company trades on is the earnings growth. 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. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.
Changhong Jiahua Holdings saw earnings per share improve by -4.2% last year. And earnings per share have improved by 8.4% annually, over the last five years. Shareholders have some reason to be optimistic, but the future is always uncertain. So investors should delve deeper. I like to check if company insiders have been buying or selling.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
The 'Price' in P/E reflects the market capitalization of the company. Thus, the metric does not reflect cash or debt held by the company. The exact same company would hypothetically deserve a higher P/E ratio if it had a strong balance sheet, than if it had a weak one with lots of debt, because a cashed up company can spend on 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.
Changhong Jiahua Holdings's Balance Sheet
Net debt is 45% of Changhong Jiahua Holdings's market cap. You'd want to be aware of this fact, but it doesn't bother us.
The Bottom Line On Changhong Jiahua Holdings's P/E Ratio
Changhong Jiahua Holdings trades on a P/E ratio of 6.2, which is below the HK market average of 10.1. The company does have a little debt, and EPS is moving in the right direction. If growth is sustainable over the long term, then the current P/E ratio may be a sign of good value.
Investors should be looking to buy stocks that the market is wrong about. If the reality for a company is not as bad as the P/E ratio indicates, then the share price should increase as the market realizes this. We don't have analyst forecasts, but you might want to assess this data-rich visualization of earnings, revenue and cash flow.
You might be able to find a better buy than Changhong Jiahua 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).
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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.
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. Thank you for reading.