Here's What Speed Apparel Holding Limited's (HKG:3860) P/E Is Telling Us

Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll look at Speed Apparel Holding Limited's (HKG:3860) P/E ratio and reflect on what it tells us about the company's share price. Based on the last twelve months, Speed Apparel Holding's P/E ratio is 7.48. In other words, at today's prices, investors are paying HK$7.48 for every HK$1 in prior year profit.

Check out our latest analysis for Speed Apparel Holding

How Do You Calculate A P/E Ratio?

The formula for price to earnings is:

Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)

Or for Speed Apparel Holding:

P/E of 7.48 = HK$0.520 ÷ HK$0.069 (Based on the trailing twelve months to September 2019.)

(Note: the above calculation results may not be precise due to rounding.)

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'.

Does Speed Apparel Holding Have A Relatively High Or Low P/E For Its Industry?

We can get an indication of market expectations by looking at the P/E ratio. You can see in the image below that the average P/E (7.4) for companies in the luxury industry is roughly the same as Speed Apparel Holding's P/E.

Speed Apparel Holding's P/E tells us that market participants think its prospects are roughly in line with its industry. So if Speed Apparel Holding actually outperforms its peers going forward, that should be a positive for the share price. Checking factors such as director buying and selling. could help you form your own view on if that will happen.

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. Earnings growth means that in the future the 'E' will be higher. And in that case, the P/E ratio itself will drop rather quickly. And as that P/E ratio drops, the company will look cheap, unless its share price increases.

It's nice to see that Speed Apparel Holding grew EPS by a stonking 42% in the last year. And earnings per share have improved by 20% annually, over the last five years. I'd therefore be a little surprised if its P/E ratio was not relatively high.

Don't Forget: The P/E Does Not Account For Debt or Bank Deposits

It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. Thus, the metric does not reflect cash or debt held by the company. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.

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.

So What Does Speed Apparel Holding's Balance Sheet Tell Us?

With net cash of HK$71m, Speed Apparel Holding has a very strong balance sheet, which may be important for its business. Having said that, at 27% of its market capitalization the cash hoard would contribute towards a higher P/E ratio.

The Bottom Line On Speed Apparel Holding's P/E Ratio

Speed Apparel Holding has a P/E of 7.5. That's below the average in the HK market, which is 9.1. It grew its EPS nicely over the last year, and the healthy balance sheet implies there is more potential for growth. One might conclude that the market is a bit pessimistic, given the low P/E ratio.

Investors have an opportunity when market expectations about a stock are wrong. If the reality for a company is not as bad as the P/E ratio indicates, then the share price should increase as the market realizes this. Although we don't have analyst forecasts shareholders might want to examine this detailed historical graph of earnings, revenue and cash flow.

Of course you might be able to find a better stock than Speed Apparel Holding. So you may wish to see this free collection of other companies that have grown earnings strongly.

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.