This article is written for those who want to get better at using price to earnings ratios (P/E ratios).
We’ll apply a basic P/E ratio analysis to O-Net Technologies (Group) Limited’s (HKG:877), to help you decide if the stock is worth further research.
What is O-Net Technologies (Group)’s P/E ratio? Well, based on the last twelve months it is 13.59.
That means that at current prices, buyers pay HK$13.59 for every HK$1 in trailing yearly profits.
How Do You Calculate A P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for O-Net Technologies (Group):
P/E of 13.59 = HK$4.75 ÷ HK$0.35
(Based on the year to December 2018.)
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.
All else being equal, it’s better to pay a low price — but as Warren Buffett said, ‘It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.’
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.
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.
And as that P/E ratio drops, the company will look cheap, unless its share price increases.
O-Net Technologies (Group) increased earnings per share by a whopping 26% last year.
And it has bolstered its earnings per share by 81% per year over the last five years.
I’d therefore be a little surprised if its P/E ratio was not relatively high.
Does O-Net Technologies (Group) Have A Relatively High Or Low P/E For Its Industry?
The P/E ratio essentially measures market expectations of a company.
You can see in the image below that the average P/E (12.6) for companies in the communications industry is lower than O-Net Technologies (Group)’s P/E.
That means that the market expects O-Net Technologies (Group) will outperform other companies in its industry.
Clearly the market expects growth, but it isn’t guaranteed.
So further research is always essential. I often monitor director buying and selling.
Remember: P/E Ratios Don’t Consider The Balance Sheet
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet.
Thus, the metric does not reflect cash or debt held by the company.
In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.
Such spending might be good or bad, overall, but the key point here is that you need to look at debt to understand the P/E ratio in context.
O-Net Technologies (Group)’s Balance Sheet
O-Net Technologies (Group)’s net debt is 3.5% of its market cap.
So it doesn’t have as many options as it would with net cash, but its debt would not have much of an impact on its P/E ratio.
The Bottom Line On O-Net Technologies (Group)’s P/E Ratio
O-Net Technologies (Group) has a P/E of 13.6. That’s higher than the average in the HK market, which is 12.1.
Its debt levels do not imperil its balance sheet and it is growing EPS strongly.
Therefore, it’s not particularly surprising that it has a above average P/E ratio.
When the market is wrong about a stock, it gives savvy investors an opportunity.
As value investor Benjamin Graham famously said, ‘In the short run, the market is a voting machine but in the long run, it is a weighing machine.’
So this free report on the analyst consensus forecasts could help you make a master move on this stock.
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.
Discounted cash flow calculation for every stock
Simply Wall St does a detailed discounted cash flow calculation every 6 hours for every stock on the market, so if you want to find the intrinsic value of any company just search here. It’s FREE.