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This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We’ll show how you can use First Pacific Company Limited’s (HKG:142) P/E ratio to inform your assessment of the investment opportunity. First Pacific has a P/E ratio of 15.15, based on the last twelve months. That means that at current prices, buyers pay HK$15.15 for every HK$1 in trailing yearly profits.
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How Do I Calculate First Pacific’s Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Share Price (in reporting currency) ÷ Earnings per Share (EPS)
Or for First Pacific:
P/E of 15.15 = $0.43 (Note: this is the share price in the reporting currency, namely, USD ) ÷ $0.028 (Based on the year to June 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. All else being equal, it’s better to pay a low price — but as Warren Buffett said, ‘It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.’
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. When earnings grow, the ‘E’ increases, over time. 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.
Most would be impressed by First Pacific earnings growth of 12% in the last year. And its annual EPS growth rate over 3 years is 36%. This could arguably justify a relatively high P/E ratio. In contrast, EPS has decreased by 23%, annually, over 5 years.
How Does First Pacific’s P/E Ratio Compare To Its Peers?
We can get an indication of market expectations by looking at the P/E ratio. As you can see below, First Pacific has a higher P/E than the average company (12.5) in the diversified financial industry.
First Pacific’s P/E tells us that market participants think the company will perform better than its industry peers, going forward. Clearly the market expects growth, but it isn’t guaranteed. So further research is always essential. I often monitor director buying and selling.
Remember: P/E Ratios Don’t Consider The Balance Sheet
It’s important to note that the P/E ratio considers the market capitalization, not the enterprise value. 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.