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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 NagaCorp Ltd.'s (HKG:3918) P/E ratio could help you assess the value on offer. NagaCorp has a price to earnings ratio of 14.47, based on the last twelve months. That means that at current prices, buyers pay HK$14.47 for every HK$1 in trailing yearly profits.
Check out our latest analysis for NagaCorp
How Do You Calculate NagaCorp's P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price (in reporting currency) ÷ Earnings per Share (EPS)
Or for NagaCorp:
P/E of 14.47 = USD1.52 (Note: this is the share price in the reporting currency, namely, USD ) ÷ USD0.10 (Based on the trailing twelve months 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 USD1 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 NagaCorp Have A Relatively High Or Low P/E For Its Industry?
One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. You can see in the image below that the average P/E (12.7) for companies in the hospitality industry is lower than NagaCorp's P/E.
That means that the market expects NagaCorp will outperform other companies in its industry. The market is optimistic about the future, but that doesn't guarantee future growth. So further research is always essential. 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. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. That means unless the share price increases, the P/E will reduce in a few years. And as that P/E ratio drops, the company will look cheap, unless its share price increases.
In the last year, NagaCorp grew EPS like Taylor Swift grew her fan base back in 2010; the 53% gain was both fast and well deserved. Having said that, the average EPS growth over the last three years wasn't so good, coming in at 6.7%.
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. 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.