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This article is written for those who want to get better at using price to earnings ratios (P/E ratios). To keep it practical, we’ll show how Royale Furniture Holdings Limited’s (

HKG:1198

) P/E ratio could help you assess the value on offer.

Royale Furniture Holdings has a price to earnings ratio of 36.74

, based on the last twelve months. That is equivalent to an earnings yield of about 2.7%.

Check out our latest analysis for Royale Furniture Holdings

How Do You Calculate A P/E Ratio?

The

formula for P/E

is:

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

Or for Royale Furniture Holdings:

P/E of 36.74 = HK$0.91 ÷ HK$0.025 (Based on the year to June 2018.)

Is A High P/E Ratio Good?

A higher P/E ratio means that investors are paying

a higher price

for each HK$1 of company earnings. That is not a good or a bad thing

per se

, but a high P/E does imply buyers are optimistic about the future.

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. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. A lower P/E should indicate the stock is cheap relative to others — and that may attract buyers.

Royale Furniture Holdings saw earnings per share decrease by 4.0% last year. But it has grown its earnings per share by 65% per year over the last five years.

How Does Royale Furniture Holdings’s P/E Ratio Compare To Its Peers?

The P/E ratio essentially measures market expectations of a company. You can see in the image below that the average P/E (11.3) for companies in the consumer durables industry is a lot lower than Royale Furniture Holdings’s P/E.

SEHK:1198 PE PEG Gauge February 1st 19

Its relatively high P/E ratio indicates that Royale Furniture Holdings shareholders think it will perform better than other companies in its industry classification. Shareholders are clearly optimistic, but the future is always uncertain. So investors should delve deeper. I like to check

if company insiders have been buying or selling

.

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

Don’t forget that the P/E ratio considers market capitalization. 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 taking on debt (or spending its remaining cash).

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.

Is Debt Impacting Royale Furniture Holdings’s P/E?

Royale Furniture Holdings’s net debt is 21% of its market cap. This could bring some additional risk, and reduce the number of investment options for management; worth remembering if you compare its P/E to businesses without debt.

The Verdict On Royale Furniture Holdings’s P/E Ratio

Royale Furniture Holdings trades on a P/E ratio of 36.7, which is multiples above the HK market average of 10.3. With a bit of debt, but a lack of recent growth, it’s safe to say the market is expecting improved profit performance from the company, in the next few years.

Investors should be looking to buy stocks that the market is wrong about. People often underestimate remarkable growth — so investors can make money when fast growth is not fully appreciated. 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 Royale Furniture 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).

To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at

[email protected]

.

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