In This Article:
The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We'll look at Essex Bio-Technology Limited's (HKG:1061) P/E ratio and reflect on what it tells us about the company's share price. Essex Bio-Technology has a price to earnings ratio of 11.48, based on the last twelve months. In other words, at today's prices, investors are paying HK$11.48 for every HK$1 in prior year profit.
View our latest analysis for Essex Bio-Technology
How Do You Calculate A P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Essex Bio-Technology:
P/E of 11.48 = HK$5.21 ÷ HK$0.45 (Based on the year to June 2019.)
Is A High P/E Ratio Good?
A higher P/E ratio means that buyers have to pay a higher price for each HK$1 the company has earned over the last year. That is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.
Does Essex Bio-Technology Have A Relatively High Or Low P/E For Its Industry?
The P/E ratio essentially measures market expectations of a company. We can see in the image below that the average P/E (14.2) for companies in the biotechs industry is higher than Essex Bio-Technology's P/E.
Essex Bio-Technology's P/E tells us that market participants think it will not fare as well as its peers in the same industry. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. 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
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 unless the share price increases, the P/E will reduce in a few years. Then, a lower P/E should attract more buyers, pushing the share price up.
Notably, Essex Bio-Technology grew EPS by a whopping 35% in the last year. And it has bolstered its earnings per share by 34% per year over the last five years. So we'd generally expect it to have a relatively high P/E ratio.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
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.