This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We’ll apply a basic P/E ratio analysis to Moda-InnoChips Co., Ltd.’s (KOSDAQ:080420), to help you decide if the stock is worth further research. Looking at earnings over the last twelve months, Moda-InnoChips has a P/E ratio of 20.85. That corresponds to an earnings yield of approximately 4.8%.

View our latest analysis for Moda-InnoChips

How Do I Calculate Moda-InnoChips’s Price To Earnings Ratio?

The formula for P/E is:

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

Or for Moda-InnoChips:

P/E of 20.85 = KRW3250.00 ÷ KRW155.91 (Based on the trailing twelve months to September 2019.)

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. 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 Does Moda-InnoChips’s P/E Ratio Compare To Its Peers?

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 (15.1) for companies in the electronic industry is lower than Moda-InnoChips’s P/E.

KOSDAQ:A080420 Price Estimation Relative to Market, January 29th 2020
KOSDAQ:A080420 Price Estimation Relative to Market, January 29th 2020

Its relatively high P/E ratio indicates that Moda-InnoChips shareholders think it will perform better than other companies in its industry classification. Clearly the market expects growth, but it isn’t guaranteed. So further research is always essential. I often monitor director buying and selling.

How Growth Rates Impact P/E Ratios

Companies that shrink earnings per share quickly will rapidly decrease the ‘E’ in the equation. That means even if the current P/E is low, it will increase over time if the share price stays flat. Then, a higher P/E might scare off shareholders, pushing the share price down.

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Moda-InnoChips saw earnings per share decrease by 68% last year. And EPS is down 26% a year, over the last 5 years. This growth rate might warrant a below average P/E ratio.

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. 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.

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.

How Does Moda-InnoChips’s Debt Impact Its P/E Ratio?

Moda-InnoChips has net debt worth 87% of its market capitalization. This is a reasonably significant level of debt — all else being equal you’d expect a much lower P/E than if it had net cash.

The Verdict On Moda-InnoChips’s P/E Ratio

Moda-InnoChips trades on a P/E ratio of 20.8, which is above its market average of 15.7. With relatively high debt, and no earnings per share growth over twelve months, it’s safe to say the market believes the company will improve its earnings growth in the future.

Investors should be looking to buy stocks that the market is wrong about. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. We don’t have analyst forecasts, but shareholders might want to examine this detailed historical graph of earnings, revenue and cash flow.

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But note: Moda-InnoChips 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).

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.

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