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 Red Star Macalline Group Corporation Ltd.'s (HKG:1528) P/E ratio could help you assess the value on offer. Looking at earnings over the last twelve months, Red Star Macalline Group has a P/E ratio of 5.46. In other words, at today's prices, investors are paying HK$5.46 for every HK$1 in prior year profit.
How Do You Calculate Red Star Macalline Group's P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share (in the reporting currency) ÷ Earnings per Share (EPS)
Or for Red Star Macalline Group:
P/E of 5.46 = CN¥6.55 (Note: this is the share price in the reporting currency, namely, CNY ) ÷ CN¥1.2 (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 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
If earnings fall then in the future the 'E' will be lower. That means unless the share price falls, the P/E will increase in a few years. Then, a higher P/E might scare off shareholders, pushing the share price down.
Red Star Macalline Group's earnings per share grew by -6.2% in the last twelve months. And it has bolstered its earnings per share by 3.5% per year over the last five years.
Does Red Star Macalline 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 Red Star Macalline Group has a lower P/E than the average (6.8) P/E for companies in the real estate industry.
This suggests that market participants think Red Star Macalline Group will underperform other companies in its industry. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and selling.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
Don't forget that the P/E ratio considers market capitalization. That means it doesn't take debt or cash into account. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
While growth expenditure doesn't always pay off, the point is that it is a good option to have; but one that the P/E ratio ignores.
So What Does Red Star Macalline Group's Balance Sheet Tell Us?
Red Star Macalline Group's net debt is 69% of its market cap. 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 Verdict On Red Star Macalline Group's P/E Ratio
Red Star Macalline Group trades on a P/E ratio of 5.5, which is below the HK market average of 12.1. It's good to see EPS growth in the last 12 months, but the debt on the balance sheet might be muting expectations.
Investors should be looking to buy stocks that the market is wrong about. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.
Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.
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.
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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. Thank you for reading.