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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 Hengan International Group Company Limited's (HKG:1044) P/E ratio could help you assess the value on offer. Looking at earnings over the last twelve months, Hengan International Group has a P/E ratio of 16.18. That corresponds to an earnings yield of approximately 6.2%.
See our latest analysis for Hengan International Group
How Do You Calculate Hengan International Group's P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Share Price (in reporting currency) ÷ Earnings per Share (EPS)
Or for Hengan International Group:
P/E of 16.18 = CN¥51 (Note: this is the share price in the reporting currency, namely, CNY ) ÷ CN¥3.15 (Based on the year to December 2018.)
Is A High P/E 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 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
Generally speaking the rate of earnings growth has a profound impact on a company's P/E multiple. Earnings growth means that in the future the 'E' will be higher. That means unless the share price increases, the P/E will reduce in a few years. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.
Hengan International Group maintained roughly steady earnings over the last twelve months. But over the longer term (5 years) earnings per share have increased by 5.9%.
Does Hengan International Group Have A Relatively High Or Low P/E For Its Industry?
The P/E ratio essentially measures market expectations of a company. If you look at the image below, you can see Hengan International Group has a lower P/E than the average (19) in the personal products industry classification.
Its relatively low P/E ratio indicates that Hengan International Group shareholders think it will struggle to do as well as other companies in its industry classification. 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.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
Don't forget that the P/E ratio considers market capitalization. That means it doesn't take debt or cash into account. Theoretically, a business can improve its earnings (and produce a lower P/E in the future) by investing in growth. That means taking on debt (or spending its cash).