This article is written for those who want to get better at using price to earnings ratios (P/E ratios). To keep it practical, we’ll show how Magnificent Hotel Investments Limited’s (HKG:201) P/E ratio could help you assess the value on offer. Magnificent Hotel Investments has a P/E ratio of 8.31, based on the last twelve months. That corresponds to an earnings yield of approximately 12%.

View our latest analysis for Magnificent Hotel Investments

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 Magnificent Hotel Investments:

P/E of 8.31 = HK$0.18 ÷ HK$0.021 (Based on the year to June 2018.)

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.

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. When earnings grow, the ‘E’ increases, over time. That means even if the current P/E is high, it will reduce over time if the share price stays flat. Then, a lower P/E should attract more buyers, pushing the share price up.

Notably, Magnificent Hotel Investments grew EPS by a whopping 45% in the last year. And its annual EPS growth rate over 3 years is 19%. I’d therefore be a little surprised if its P/E ratio was not relatively high. But earnings per share are down 43% per year over the last five years.

How Does Magnificent Hotel Investments’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 Magnificent Hotel Investments has a lower P/E than the average (14) P/E for companies in the hospitality industry.

This suggests that market participants think Magnificent Hotel Investments will underperform other companies in its industry. Many investors like to buy stocks when the market is pessimistic about their prospects. You should delve deeper. I like to check if company insiders have been buying or selling.

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

The ‘Price’ in P/E reflects the market capitalization of the company. Thus, the metric does not reflect cash or debt held by the company. Theoretically, a business can improve its earnings (and produce a lower P/E in the future), by taking on debt (or spending its remaining cash).