Why Datasonic Group Berhad's (KLSE:DSONIC) High P/E Ratio Isn't Necessarily A Bad Thing

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 Datasonic Group Berhad's (KLSE:DSONIC) P/E ratio to inform your assessment of the investment opportunity. Datasonic Group Berhad has a price to earnings ratio of 36.19, based on the last twelve months. In other words, at today's prices, investors are paying MYR36.19 for every MYR1 in prior year profit.

Check out our latest analysis for Datasonic Group Berhad

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 Datasonic Group Berhad:

P/E of 36.19 = MYR1.30 ÷ MYR0.04 (Based on the year to September 2019.)

Is A High Price-to-Earnings Ratio Good?

A higher P/E ratio implies that investors pay a higher price for the earning power of the business. 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.

Does Datasonic Group Berhad 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. The image below shows that Datasonic Group Berhad has a higher P/E than the average (21.1) P/E for companies in the it industry.

Its relatively high P/E ratio indicates that Datasonic Group Berhad shareholders think it will perform better than other companies in its industry classification. Shareholders are clearly optimistic, but the future is always uncertain. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.

How Growth Rates Impact P/E Ratios

When earnings fall, the 'E' decreases, over time. Therefore, even if you pay a low multiple of earnings now, that multiple will become higher in the future. A higher P/E should indicate the stock is expensive relative to others -- and that may encourage shareholders to sell.

Datasonic Group Berhad maintained roughly steady earnings over the last twelve months. And EPS is down 7.7% a year, over the last 5 years. So you wouldn't expect a very high P/E.

Remember: P/E Ratios Don't Consider The Balance Sheet

One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. Thus, the metric does not reflect cash or debt held by the company. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.

While growth expenditure doesn't always pay off, the point is that it is a good option to have; but one that the P/E ratio ignores.

Datasonic Group Berhad's Balance Sheet

Datasonic Group Berhad has net debt worth just 3.6% of its market capitalization. So it doesn't have as many options as it would with net cash, but its debt would not have much of an impact on its P/E ratio.

The Bottom Line On Datasonic Group Berhad's P/E Ratio

Datasonic Group Berhad trades on a P/E ratio of 36.2, which is above its market average of 14.6. With modest debt relative to its size, and modest earnings growth, the market is likely expecting sustained long-term growth, if not a near-term improvement.

Investors have an opportunity when market expectations about a stock are wrong. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. So this free report on the analyst consensus forecasts could help you make a master move on this stock.

Of course you might be able to find a better stock than Datasonic Group Berhad. So you may wish to see this free collection of other companies that have grown earnings strongly.

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.

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.