In This Article:
The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). To keep it practical, we'll show how Crystal International Group Limited's (HKG:2232) P/E ratio could help you assess the value on offer. Crystal International Group has a P/E ratio of 7.85, based on the last twelve months. That corresponds to an earnings yield of approximately 13%.
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See our latest analysis for Crystal International Group
How Do I Calculate A Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share (in the reporting currency) ÷ Earnings per Share (EPS)
Or for Crystal International Group:
P/E of 7.85 = $0.41 (Note: this is the share price in the reporting currency, namely, USD ) ÷ $0.052 (Based on the year to December 2018.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio means that investors are paying a higher price for each HK$1 of company earnings. 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. Earnings growth means that in the future the 'E' will be higher. That means even if the current P/E is high, it will reduce over time if the share price stays flat. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.
Crystal International Group saw earnings per share decrease by 15% last year. But EPS is up 8.1% over the last 5 years.
How Does Crystal International Group's P/E Ratio Compare To Its Peers?
We can get an indication of market expectations by looking at the P/E ratio. If you look at the image below, you can see Crystal International Group has a lower P/E than the average (9.5) in the luxury industry classification.
Crystal International Group's P/E tells us that market participants think it will not fare as well as its peers in the same industry. Since the market seems unimpressed with Crystal International Group, it's quite possible it could surprise on the upside. 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
Don't forget that the P/E ratio considers market capitalization. So it won't reflect the advantage of cash, or disadvantage of debt. Theoretically, a business can improve its earnings (and produce a lower P/E in the future) by investing in growth. That means taking on debt (or spending its cash).