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 Cabbeen Fashion Limited's (HKG:2030) P/E ratio to inform your assessment of the investment opportunity. Cabbeen Fashion has a P/E ratio of 4.93, based on the last twelve months. In other words, at today's prices, investors are paying HK$4.93 for every HK$1 in prior year profit.

See our latest analysis for Cabbeen Fashion

How Do I Calculate A 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 Cabbeen Fashion:

P/E of 4.93 = CN¥1.164 ÷ CN¥0.236 (Based on the trailing twelve months to December 2019.)

(Note: the above calculation uses the share price in the reporting currency, namely CNY and the calculation results may not be precise due to rounding.)

Is A High Price-to-Earnings Ratio Good?

A higher P/E ratio means that buyers have to pay a higher price for each CN¥1 the company has earned over the last year. That isn't a good or a bad thing on its own, but a high P/E means that buyers have a higher opinion of the business's prospects, relative to stocks with a lower P/E.

Does Cabbeen Fashion 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. We can see in the image below that the average P/E (7.4) for companies in the luxury industry is higher than Cabbeen Fashion's P/E.

Cabbeen Fashion'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 Cabbeen Fashion, 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.

How Growth Rates Impact P/E Ratios

When earnings fall, the 'E' decreases, over time. Therefore, even if you pay a low multiple of earnings now, that multiple will become higher in the future. So while a stock may look cheap based on past earnings, it could be expensive based on future earnings.

Cabbeen Fashion's earnings per share fell by 26% in the last twelve months. And over the longer term (5 years) earnings per share have decreased 6.6% annually. This could justify a pessimistic P/E.

Don't Forget: The P/E Does Not Account For Debt or Bank Deposits

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. 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.