Today, we’ll introduce the concept of the P/E ratio for those who are learning about investing. To keep it practical, we’ll show how Ever-Glory International Group, Inc.’s (NASDAQ:EVK) P/E ratio could help you assess the value on offer. Ever-Glory International Group has a price to earnings ratio of 4.62, based on the last twelve months. In other words, at today’s prices, investors are paying $4.62 for every $1 in prior year profit.
How Do I Calculate A Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Ever-Glory International Group:
P/E of 4.62 = $3.75 ÷ $0.81 (Based on the trailing twelve months to December 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 $1 the company has earned over the last year. 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
Companies that shrink earnings per share quickly will rapidly decrease the ‘E’ in the equation. That means even if the current P/E is low, it will increase over time if the share price stays flat. So while a stock may look cheap based on past earnings, it could be expensive based on future earnings.
Ever-Glory International Group saw earnings per share decrease by 3.6% last year. But over the longer term (5 years) earnings per share have increased by 2.2%. And it has shrunk its earnings per share by 4.0% per year over the last three years. This growth rate might warrant a low P/E ratio. So it would be surprising to see a high P/E.
Does Ever-Glory International Group Have A Relatively High Or Low P/E For Its Industry?
One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. The image below shows that Ever-Glory International Group has a lower P/E than the average (17.4) P/E for companies in the luxury industry.
Its relatively low P/E ratio indicates that Ever-Glory International Group shareholders think it will struggle to do as well as other companies in its industry classification. Since the market seems unimpressed with Ever-Glory International Group, it’s quite possible it could surprise on the upside. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and selling.
Don’t Forget: The P/E Does Not Account For Debt or Bank Deposits
It’s important to note that the P/E ratio considers the market capitalization, not the enterprise value. That means it doesn’t take debt or cash into account. 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.
Is Debt Impacting Ever-Glory International Group’s P/E?
With net cash of US$18m, Ever-Glory International Group has a very strong balance sheet, which may be important for its business. Having said that, at 32% of its market capitalization the cash hoard would contribute towards a higher P/E ratio.
The Bottom Line On Ever-Glory International Group’s P/E Ratio
Ever-Glory International Group trades on a P/E ratio of 4.6, which is below the US market average of 18.2. The recent drop in earnings per share would make investors cautious, the healthy balance sheet means the company retains potential for future growth. If that occurs, the current low P/E could prove to be temporary.
When the market is wrong about a stock, it gives savvy investors an opportunity. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. Although we don’t have analyst forecasts, you could get a better understanding of its growth by checking out this more detailed historical graph of earnings, revenue and cash flow.
Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.
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 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. Thank you for reading.