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This article is written for those who want to get better at using price to earnings ratios (P/E ratios). To keep it practical, we'll show how Stella International Holdings Limited's (HKG:1836) P/E ratio could help you assess the value on offer. Stella International Holdings has a P/E ratio of 15.54, based on the last twelve months. That corresponds to an earnings yield of approximately 6.4%.
See our latest analysis for Stella International Holdings
How Do I Calculate A Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price (in reporting currency) ÷ Earnings per Share (EPS)
Or for Stella International Holdings:
P/E of 15.54 = HK$1.60 (Note: this is the share price in the reporting currency, namely, USD ) ÷ HK$0.10 (Based on the year to June 2019.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio means that buyers have to pay a higher price for each HK$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.
Does Stella International Holdings 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. You can see in the image below that the average P/E (9.0) for companies in the luxury industry is lower than Stella International Holdings's P/E.
That means that the market expects Stella International Holdings will outperform other companies in its industry. The market is optimistic about the future, but that doesn't guarantee future growth. So investors should delve deeper. I like to check if company insiders have been buying or selling.
How Growth Rates Impact P/E Ratios
If earnings fall then in the future the 'E' will be lower. That means even if the current P/E is low, it will increase over time if the share price stays flat. A higher P/E should indicate the stock is expensive relative to others -- and that may encourage shareholders to sell.
It's nice to see that Stella International Holdings grew EPS by a stonking 44% in the last year. But earnings per share are down 8.2% per year over the last five years.
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. In other words, it does not consider any debt or cash that the company may have on the balance sheet. The exact same company would hypothetically deserve a higher P/E ratio if it had a strong balance sheet, than if it had a weak one with lots of debt, because a cashed up company can spend on growth.