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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 apply a basic P/E ratio analysis to Hung Fook Tong Group Holdings Limited's (HKG:1446), to help you decide if the stock is worth further research. Based on the last twelve months, Hung Fook Tong Group Holdings's P/E ratio is 26.2. That corresponds to an earnings yield of approximately 3.8%.
Check out our latest analysis for Hung Fook Tong Group Holdings
How Do I Calculate A Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Hung Fook Tong Group Holdings:
P/E of 26.2 = HK$0.50 ÷ HK$0.019 (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 is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.
Does Hung Fook Tong Group Holdings Have A Relatively High Or Low P/E For Its Industry?
The P/E ratio indicates whether the market has higher or lower expectations of a company. The image below shows that Hung Fook Tong Group Holdings has a lower P/E than the average (29.8) P/E for companies in the beverage industry.
This suggests that market participants think Hung Fook Tong Group Holdings will underperform other companies in its industry. Many investors like to buy stocks when the market is pessimistic about their prospects. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and selling.
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. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
It's nice to see that Hung Fook Tong Group Holdings grew EPS by a stonking 34% in the last year. And its annual EPS growth rate over 3 years is 12%. So we'd generally expect it to have a relatively high P/E ratio. But earnings per share are down 16% per year over the last five years.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. In other words, it does not consider any debt or cash that the company may have on the balance sheet. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.