The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We’ll look at AEON Credit Service (Asia) Company Limited’s (HKG:900) P/E ratio and reflect on what it tells us about the company’s share price. AEON Credit Service (Asia) has a P/E ratio of 6.82, based on the last twelve months. In other words, at today’s prices, investors are paying HK$6.82 for every HK$1 in prior year profit.

See our latest analysis for AEON Credit Service (Asia)

How Do You Calculate A P/E Ratio?

The formula for price to earnings is:

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

Or for AEON Credit Service (Asia):

P/E of 6.82 = HK$6.98 ÷ HK$1.02 (Based on the year to August 2018.)

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.

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. That means even if the current P/E is high, it will reduce over time if the share price stays flat. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.

Notably, AEON Credit Service (Asia) grew EPS by a whopping 34% in the last year. And it has bolstered its earnings per share by 10% per year over the last five years. So we’d generally expect it to have a relatively high P/E ratio.

How Does AEON Credit Service (Asia)’s P/E Ratio Compare To Its Peers?

The P/E ratio indicates whether the market has higher or lower expectations of a company. We can see in the image below that the average P/E (9.7) for companies in the consumer finance industry is higher than AEON Credit Service (Asia)’s P/E.

This suggests that market participants think AEON Credit Service (Asia) will underperform other companies in its industry. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.

A Limitation: P/E Ratios Ignore Debt and Cash In The Bank

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. Theoretically, a business can improve its earnings (and produce a lower P/E in the future), by taking on debt (or spending its remaining cash).