Why HC Group Inc.'s (HKG:2280) High P/E Ratio Isn't Necessarily A Bad Thing

Simply Wall St

Sat, Jun 8, 2019, 7:42 PM

This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We'll show how you can use HC Group Inc.'s (HKG:2280) P/E ratio to inform your assessment of the investment opportunity. What is HC Group's P/E ratio? Well, based on the last twelve months it is 11.42. That means that at current prices, buyers pay HK$11.42 for every HK$1 in trailing yearly profits.

View our latest analysis for HC Group

How Do You Calculate A P/E Ratio?

The formula for P/E is:

Price to Earnings Ratio = Price per Share (in the reporting currency) ÷ Earnings per Share (EPS)

Or for HC Group:

P/E of 11.42 = CN¥2.81 (Note: this is the share price in the reporting currency, namely, CNY ) ÷ CN¥0.25 (Based on the trailing twelve months to December 2018.)

Is A High P/E Ratio Good?

A higher P/E ratio means that investors are paying a higher price for each HK$1 of company earnings. 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 unless the share price increases, the P/E will reduce in a few years. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.

HC Group's earnings per share fell by 7.1% in the last twelve months. But it has grown its earnings per share by 52% per year over the last three years. And EPS is down 1.3% a year, over the last 5 years. So it would be surprising to see a high P/E.

Does HC Group Have A Relatively High Or Low P/E For Its Industry?

The P/E ratio essentially measures market expectations of a company. The image below shows that HC Group has a higher P/E than the average (9.5) P/E for companies in the trade distributors industry.

SEHK:2280 Price Estimation Relative to Market, June 9th 2019

That means that the market expects HC Group will outperform other companies in its industry. Clearly the market expects growth, but it isn't guaranteed. So investors 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. In other words, it does not consider any debt or cash that the company may have on the balance sheet. 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).