Read This Before You Buy Midea Real Estate Holding Limited (HKG:3990) Because Of Its P/E Ratio

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This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We’ll show how you can use Midea Real Estate Holding Limited’s (HKG:3990) P/E ratio to inform your assessment of the investment opportunity. Based on the last twelve months, Midea Real Estate Holding’s P/E ratio is 5.38. That is equivalent to an earnings yield of about 19%.

View our latest analysis for Midea Real Estate Holding

How Do You Calculate Midea Real Estate Holding’s P/E Ratio?

The formula for P/E is:

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

Or for Midea Real Estate Holding:

P/E of 5.38 = CN¥14.53 (Note: this is the share price in the reporting currency, namely, CNY ) ÷ CN¥2.7 (Based on the year to March 2018.)

Is A High Price-to-Earnings 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. 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.

It’s nice to see that Midea Real Estate Holding grew EPS by a stonking 65% in the last year.

How Does Midea Real Estate Holding’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 Midea Real Estate Holding has a lower P/E than the average (6.1) P/E for companies in the real estate industry.

SEHK:3990 Price Estimation Relative to Market, March 16th 2019

Its relatively low P/E ratio indicates that Midea Real Estate Holding shareholders think it will struggle to do as well as other companies in its industry classification. Many investors like to buy stocks when the market is pessimistic about their prospects. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.

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

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. 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).

Spending on growth might be good or bad a few years later, but the point is that the P/E ratio does not account for the option (or lack thereof).

Midea Real Estate Holding’s Balance Sheet

Midea Real Estate Holding’s net debt is considerable, at 156% of its market cap. This level of debt justifies a relatively low P/E, so remain cognizant of the debt, if you’re comparing it to other stocks.

The Bottom Line On Midea Real Estate Holding’s P/E Ratio

Midea Real Estate Holding trades on a P/E ratio of 5.4, which is below the HK market average of 10.8. The company may have significant debt, but EPS growth was good last year. If it continues to grow, then the current low P/E may prove to be unjustified.

Investors should be looking to buy stocks that the market is wrong about. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.

But note: Midea Real Estate Holding may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).

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.

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. Thank you for reading.