Here's How P/E Ratios Can Help Us Understand HPC Holdings Limited (HKG:1742)

The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We'll look at HPC Holdings Limited's (HKG:1742) P/E ratio and reflect on what it tells us about the company's share price. What is HPC Holdings's P/E ratio? Well, based on the last twelve months it is 2.41. That is equivalent to an earnings yield of about 41.5%.

See our latest analysis for HPC Holdings

How Do You Calculate A P/E Ratio?

The formula for P/E is:

Price to Earnings Ratio = Share Price (in reporting currency) ÷ Earnings per Share (EPS)

Or for HPC Holdings:

P/E of 2.41 = SGD0.02 (Note: this is the share price in the reporting currency, namely, SGD ) ÷ SGD0.01 (Based on the trailing twelve months to October 2019.)

Is A High Price-to-Earnings Ratio Good?

The higher the P/E ratio, the higher the price tag of a business, relative to its trailing 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 Does HPC Holdings'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 HPC Holdings has a lower P/E than the average (8.5) P/E for companies in the construction industry.

Its relatively low P/E ratio indicates that HPC Holdings shareholders think it will struggle to do as well as other companies in its industry classification. Since the market seems unimpressed with HPC Holdings, it's quite possible it could surprise on the upside. You should delve deeper. I like to check if company insiders have been buying or selling.

How Growth Rates Impact P/E Ratios

When earnings fall, the 'E' decreases, over time. 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.

HPC Holdings shrunk earnings per share by 5.8% last year. And over the longer term (5 years) earnings per share have decreased 8.6% annually. So you wouldn't expect a very high P/E.

A Limitation: P/E Ratios Ignore Debt and Cash In The Bank

The 'Price' in P/E reflects the market capitalization of the company. That means it doesn't take debt or cash into account. Theoretically, a business can improve its earnings (and produce a lower P/E in the future) by investing in growth. That means taking on debt (or spending its cash).

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.

HPC Holdings's Balance Sheet

With net cash of S$19m, HPC Holdings has a very strong balance sheet, which may be important for its business. Having said that, at 53% of its market capitalization the cash hoard would contribute towards a higher P/E ratio.

The Bottom Line On HPC Holdings's P/E Ratio

HPC Holdings has a P/E of 2.4. That's below the average in the HK market, which is 9.9. The recent drop in earnings per share would almost certainly temper expectations, but the net cash position means the company has time to improve: if so, the low P/E could be an opportunity.

Investors have an opportunity when market expectations about a stock are wrong. 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. We don't have analyst forecasts, but shareholders might want to examine this detailed historical graph of earnings, revenue and cash flow.

You might be able to find a better buy than HPC 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).

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.

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. Thank you for reading.