Here’s How P/E Ratios Can Help Us Understand Bank of China Limited (HKG:3988)

This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We’ll look at Bank of China Limited’s (HKG:3988) P/E ratio and reflect on what it tells us about the company’s share price. What is Bank of China’s P/E ratio? Well, based on the last twelve months it is 4.53. That is equivalent to an earnings yield of about 22.1%.

Check out our latest analysis for Bank of China

How Do I Calculate Bank of China’s Price To Earnings Ratio?

The formula for P/E is:

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

Or for Bank of China:

P/E of 4.53 = CNY2.76 (Note: this is the share price in the reporting currency, namely, CNY ) ÷ CNY0.61 (Based on the year to September 2019.)

Is A High Price-to-Earnings Ratio Good?

The higher the P/E ratio, the higher the price tag of a business, relative to its trailing earnings. 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 Does Bank of China’s P/E Ratio Compare To Its Peers?

One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. We can see in the image below that the average P/E (5.5) for companies in the banks industry is higher than Bank of China’s P/E.

SEHK:3988 Price Estimation Relative to Market, March 2nd 2020
SEHK:3988 Price Estimation Relative to Market, March 2nd 2020

Its relatively low P/E ratio indicates that Bank of China 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

Generally speaking the rate of earnings growth has a profound impact on a company’s P/E multiple. Earnings growth means that in the future the ‘E’ will be higher. And in that case, the P/E ratio itself will drop rather quickly. And as that P/E ratio drops, the company will look cheap, unless its share price increases.

Bank of China saw earnings per share improve by -2.7% last year. And it has improved its earnings per share by 2.0% per year over the last three years.

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. Thus, the metric does not reflect cash or debt held by the company. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.

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.

Bank of China’s Balance Sheet

Bank of China has net cash of CN¥120b. This is fairly high at 12% of its market capitalization. That might mean balance sheet strength is important to the business, but should also help push the P/E a bit higher than it would otherwise be.

The Verdict On Bank of China’s P/E Ratio

Bank of China trades on a P/E ratio of 4.5, which is below the HK market average of 9.6. EPS was up modestly better over the last twelve months. Also positive, the relatively strong balance sheet will allow for investment in growth. In contrast, the P/E indicates shareholders doubt that will happen!

Investors have an opportunity when market expectations about a stock are wrong. 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 visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.

But note: Bank of China 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.