Does Wonderful Sky Financial Group Holdings Limited's (HKG:1260) P/E Ratio Signal A Buying Opportunity?

Simply Wall St

Sun, Oct 20, 2019, 6:31 PM

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 Wonderful Sky Financial Group Holdings Limited's (HKG:1260) P/E ratio could help you assess the value on offer. Looking at earnings over the last twelve months, Wonderful Sky Financial Group Holdings has a P/E ratio of 5.25. That corresponds to an earnings yield of approximately 19.1%.

See our latest analysis for Wonderful Sky Financial Group 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 Wonderful Sky Financial Group Holdings:

P/E of 5.25 = HK$0.71 ÷ HK$0.14 (Based on the year to March 2019.)

Is A High Price-to-Earnings 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 Does Wonderful Sky Financial Group Holdings's P/E Ratio Compare To Its Peers?

The P/E ratio essentially measures market expectations of a company. We can see in the image below that the average P/E (20.0) for companies in the media industry is higher than Wonderful Sky Financial Group Holdings's P/E.

SEHK:1260 Price Estimation Relative to Market, October 21st 2019

Wonderful Sky Financial Group Holdings's P/E tells us that market participants think it will not fare as well as its peers in the same industry. Since the market seems unimpressed with Wonderful Sky Financial Group Holdings, it's quite possible it could surprise on the upside. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.

How Growth Rates Impact P/E Ratios

When earnings fall, the 'E' decreases, over time. Therefore, even if you pay a low multiple of earnings now, that multiple will become higher in the future. Then, a higher P/E might scare off shareholders, pushing the share price down.

Wonderful Sky Financial Group Holdings increased earnings per share by an impressive 20% over the last twelve months. But earnings per share are down 2.5% per year over the last five years.

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

Don't forget that the P/E ratio considers market capitalization. In other words, it does not consider any debt or cash that the company may have on the balance sheet. 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.

Spending on growth might be good or bad a few years later, but the point is that the P/E ratio does not account for the option (or lack thereof).

How Does Wonderful Sky Financial Group Holdings's Debt Impact Its P/E Ratio?

With net cash of HK$149m, Wonderful Sky Financial Group Holdings has a very strong balance sheet, which may be important for its business. Having said that, at 18% of its market capitalization the cash hoard would contribute towards a higher P/E ratio.

The Bottom Line On Wonderful Sky Financial Group Holdings's P/E Ratio

Wonderful Sky Financial Group Holdings trades on a P/E ratio of 5.2, which is below the HK market average of 10.3. The net cash position gives plenty of options to the business, and the recent improvement in EPS is good to see. The relatively low P/E ratio implies the market is pessimistic.

Investors should be looking to buy stocks that the market is wrong about. 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. Although we don't have analyst forecasts you could get a better understanding of its growth by checking out this more detailed historical graph of earnings, revenue and cash flow.

You might be able to find a better buy than Wonderful Sky Financial Group Holdings. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).

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 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. Thank you for reading.

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