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 Telecom Digital Holdings Limited’s (HKG:6033) P/E ratio could help you assess the value on offer. Based on the last twelve months, Telecom Digital Holdings’s P/E ratio is 7.96. In other words, at today’s prices, investors are paying HK$7.96 for every HK$1 in prior year profit.
View our latest analysis for Telecom Digital Holdings
How Do I Calculate A Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Telecom Digital Holdings:
P/E of 7.96 = HK$2.53 ÷ HK$0.32 (Based on the year to March 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. 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.
How Growth Rates Impact P/E Ratios
P/E ratios primarily reflect market expectations around earnings growth rates. That’s because companies that grow earnings per share quickly will rapidly increase the ‘E’ in the equation. That means unless the share price increases, the P/E will reduce in a few years. Then, a lower P/E should attract more buyers, pushing the share price up.
It’s nice to see that Telecom Digital Holdings grew EPS by a stonking 33% in the last year. And it has bolstered its earnings per share by 5.5% per year over the last five years. So we’d generally expect it to have a relatively high P/E ratio.
How Does Telecom Digital Holdings’s P/E Ratio Compare To Its Peers?
We can get an indication of market expectations by looking at the P/E ratio. The image below shows that Telecom Digital Holdings has a P/E ratio that is roughly in line with the electronic industry average (8.2).
Its P/E ratio suggests that Telecom Digital Holdings shareholders think that in the future it will perform about the same as other companies in its industry classification. If the company has better than average prospects, then the market might be underestimating it. Further research into factors such asmanagement tenure, could help you form your own view on whether that is likely.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
The ‘Price’ in P/E reflects the market capitalization of the company. That means it doesn’t take debt or cash into account. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.