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 China Ludao Technology Company Limited’s (HKG:2023) P/E ratio could help you assess the value on offer. China Ludao Technology has a price to earnings ratio of 19.44, based on the last twelve months. That means that at current prices, buyers pay HK$19.44 for every HK$1 in trailing yearly profits.
How Do You Calculate A 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 Ludao Technology:
P/E of 19.44 = CN¥0.92 (Note: this is the share price in the reporting currency, namely, CNY ) ÷ CN¥0.048 (Based on the trailing twelve months to December 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. That isn’t a good or a bad thing on its own, but a high P/E means that buyers have a higher opinion of the business’s prospects, relative to stocks with a lower P/E.
Does China Ludao Technology 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 Ludao Technology has a P/E ratio that is roughly in line with the household products industry average (19.5).
Its P/E ratio suggests that China Ludao Technology shareholders think that in the future it will perform about the same as other companies in its industry classification.
How Growth Rates Impact P/E Ratios
Earnings growth rates have a big influence on P/E ratios. When earnings grow, the ‘E’ increases, over time. That means unless the share price increases, the P/E will reduce in a few years. Then, a lower P/E should attract more buyers, pushing the share price up.
China Ludao Technology’s earnings per share grew by -4.4% in the last twelve months. And its annual EPS growth rate over 3 years is 82%. In contrast, EPS has decreased by 8.6%, annually, over 5 years.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
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).
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.
China Ludao Technology’s Balance Sheet
China Ludao Technology has net debt worth 18% of its market capitalization. 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 China Ludao Technology’s P/E Ratio
China Ludao Technology trades on a P/E ratio of 19.4, which is above its market average of 10.6. With debt at prudent levels and improving earnings, it’s fair to say the market expects steady progress 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. Although we don’t have analyst forecasts, you could get a better understanding of its growth by checking out this more detailed historical graph of earnings, revenue and cash flow.
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.
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 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. Thank you for reading.