Here's How P/E Ratios Can Help Us Understand Lum Chang Holdings Limited (SGX:L19)

Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. To keep it practical, we'll show how Lum Chang Holdings Limited's (SGX:L19) P/E ratio could help you assess the value on offer. Lum Chang Holdings has a P/E ratio of 5.27, based on the last twelve months. That corresponds to an earnings yield of approximately 19.0%.

See our latest analysis for Lum Chang Holdings

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 Lum Chang Holdings:

P/E of 5.27 = SGD0.36 ÷ SGD0.07 (Based on the trailing twelve months to December 2019.)

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 Does Lum Chang Holdings's P/E Ratio Compare To Its Peers?

We can get an indication of market expectations by looking at the P/E ratio. If you look at the image below, you can see Lum Chang Holdings has a lower P/E than the average (15.2) in the construction industry classification.

This suggests that market participants think Lum Chang Holdings will underperform other companies in its industry. Since the market seems unimpressed with Lum Chang Holdings, it's quite possible it could surprise on the upside. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and selling.

How Growth Rates Impact P/E Ratios

P/E ratios primarily reflect market expectations around earnings growth rates. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. 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.

It's nice to see that Lum Chang Holdings grew EPS by a stonking 42% in the last year. And it has bolstered its earnings per share by 8.8% per year over the last five years. With that performance, I would expect it to have an above average P/E ratio.

Remember: P/E Ratios Don't Consider The Balance Sheet

Don't forget that the P/E ratio considers market capitalization. So it won't reflect the advantage of cash, or disadvantage of debt. 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.

Such expenditure might be good or bad, in the long term, but the point here is that the balance sheet is not reflected by this ratio.

Is Debt Impacting Lum Chang Holdings's P/E?

Lum Chang Holdings has net debt worth 56% of its market capitalization. This is enough debt that you'd have to make some adjustments before using the P/E ratio to compare it to a company with net cash.

The Bottom Line On Lum Chang Holdings's P/E Ratio

Lum Chang Holdings's P/E is 5.3 which is below average (13.4) in the SG market. While the EPS growth last year was strong, the significant debt levels reduce the number of options available to management. If it continues to grow, then the current low P/E may prove to be unjustified.

When the market is wrong about a stock, it gives savvy investors an opportunity. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. Although we don't have analyst forecasts shareholders might want to examine this detailed historical graph of earnings, revenue and cash flow.

But note: Lum Chang Holdings may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.