Today, we’ll introduce the concept of the P/E ratio for those who are learning about investing. To keep it practical, we’ll show how China Communications Construction Company Limited’s (HKG:1800) P/E ratio could help you assess the value on offer. Looking at earnings over the last twelve months, China Communications Construction has a P/E ratio of 4.18. That corresponds to an earnings yield of approximately 23.9%.
How Do You Calculate China Communications Construction’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 China Communications Construction:
P/E of 4.18 = CNY4.95 (Note: this is the share price in the reporting currency, namely, CNY ) ÷ CNY1.19 (Based on the year to September 2019.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio means that investors are paying a higher price for each CNY1 of company earnings. That isn’t necessarily good or bad, but a high P/E implies relatively high expectations of what a company can achieve in the future.
Does China Communications Construction 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. The image below shows that China Communications Construction has a lower P/E than the average (9.4) P/E for companies in the construction industry.
Its relatively low P/E ratio indicates that China Communications Construction shareholders think it will struggle to do as well as other companies in its industry classification. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and selling.
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. That’s because companies that grow earnings per share quickly will rapidly increase the ‘E’ in the equation. That means even if the current P/E is high, it will reduce over time if the share price stays flat. And as that P/E ratio drops, the company will look cheap, unless its share price increases.
China Communications Construction saw earnings per share decrease by 6.1% last year. But it has grown its earnings per share by 6.9% per year over the last five years.
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. That means it doesn’t take debt or cash into account. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
Such expenditure might be good or bad, in the long term, but the point here is that the balance sheet is not reflected by this ratio.
How Does China Communications Construction’s Debt Impact Its P/E Ratio?
China Communications Construction has net debt worth a very significant 223% of its market capitalization. This is a relatively high level of debt, so the stock probably deserves a relatively low P/E ratio. Keep that in mind when comparing it to other companies.
The Bottom Line On China Communications Construction’s P/E Ratio
China Communications Construction has a P/E of 4.2. That’s below the average in the HK market, which is 9.9. When you consider that the company has significant debt, and didn’t grow EPS last year, it isn’t surprising that the market has muted expectations.
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. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.
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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