The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). To keep it practical, we’ll show how China Mengniu Dairy Company Limited’s (HKG:2319) P/E ratio could help you assess the value on offer. China Mengniu Dairy has a price to earnings ratio of 31.37, based on the last twelve months. That means that at current prices, buyers pay HK$31.37 for every HK$1 in trailing yearly profits.
How Do I Calculate China Mengniu Dairy’s Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share (in the reporting currency) ÷ Earnings per Share (EPS)
Or for China Mengniu Dairy:
P/E of 31.37 = HK$28.57 (Note: this is the share price in the reporting currency, namely, CNY ) ÷ HK$0.91 (Based on the year to June 2019.)
Is A High P/E 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.
Does China Mengniu Dairy Have A Relatively High Or Low P/E For Its Industry?
The P/E ratio indicates whether the market has higher or lower expectations of a company. As you can see below, China Mengniu Dairy has a higher P/E than the average company (16.0) in the food industry.
That means that the market expects China Mengniu Dairy will outperform other companies in its industry. The market is optimistic about the future, but that doesn’t guarantee future growth. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.
How Growth Rates Impact P/E Ratios
P/E ratios primarily reflect market expectations around earnings growth rates. 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. And as that P/E ratio drops, the company will look cheap, unless its share price increases.
Notably, China Mengniu Dairy grew EPS by a whopping 43% in the last year. And its annual EPS growth rate over 5 years is 12%. 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
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).
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).
Is Debt Impacting China Mengniu Dairy’s P/E?
The extra options and safety that comes with China Mengniu Dairy’s CN¥3.3b net cash position means that it deserves a higher P/E than it would if it had a lot of net debt.
The Verdict On China Mengniu Dairy’s P/E Ratio
China Mengniu Dairy trades on a P/E ratio of 31.4, which is above its market average of 10.5. The excess cash it carries is the gravy on top its fast EPS growth. So based on this analysis we’d expect China Mengniu Dairy to have a high P/E ratio.
When the market is wrong about a stock, it gives savvy investors an opportunity. 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. So this free report on the analyst consensus forecasts could help you make a master move on this stock.
Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.
If you spot an error that warrants correction, please contact the editor at email@example.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.
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