In This Article:
This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We’ll look at Sisram Medical Ltd’s (HKG:1696) P/E ratio and reflect on what it tells us about the company’s share price. Based on the last twelve months, Sisram Medical’s P/E ratio is 14.16. That corresponds to an earnings yield of approximately 7.1%.
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How Do You Calculate A P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share (in the reporting currency) ÷ Earnings per Share (EPS)
Or for Sisram Medical:
P/E of 14.16 = $0.52 (Note: this is the share price in the reporting currency, namely, USD ) ÷ $0.037 (Based on the year to June 2018.)
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. 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
Probably the most important factor in determining what P/E a company trades on is the earnings growth. When earnings grow, the ‘E’ increases, over time. That means unless the share price increases, the P/E will reduce in a few years. A lower P/E should indicate the stock is cheap relative to others — and that may attract buyers.
Sisram Medical shrunk earnings per share by 19% over the last year.
How Does Sisram Medical’s P/E Ratio Compare To Its Peers?
We can get an indication of market expectations by looking at the P/E ratio. The image below shows that Sisram Medical has a lower P/E than the average (17.7) P/E for companies in the medical equipment industry.
This suggests that market participants think Sisram Medical will underperform other companies in its industry. Many investors like to buy stocks when the market is pessimistic about their prospects. You should delve deeper. I like to check if company insiders have been buying or selling.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
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. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.