The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We’ll look at Zhejiang New Century Hotel Management Co., Ltd.’s (HKG:1158) P/E ratio and reflect on what it tells us about the company’s share price. Looking at earnings over the last twelve months, Zhejiang New Century Hotel Management has a P/E ratio of 16.30. That means that at current prices, buyers pay HK$16.30 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 Zhejiang New Century Hotel Management:
P/E of 16.30 = CNY13.32 (Note: this is the share price in the reporting currency, namely, CNY ) ÷ CNY0.82 (Based on the trailing twelve months to June 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. 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’.
Does Zhejiang New Century Hotel Management Have A Relatively High Or Low P/E For Its Industry?
The P/E ratio essentially measures market expectations of a company. As you can see below, Zhejiang New Century Hotel Management has a higher P/E than the average company (11.8) in the hospitality industry.
Zhejiang New Century Hotel Management’s P/E tells us that market participants think the company will perform better than its industry peers, going forward. 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
Generally speaking the rate of earnings growth has a profound impact on a company’s P/E multiple. If earnings are growing quickly, then the ‘E’ in the equation will increase faster than it would otherwise. That means unless the share price increases, the P/E will reduce in a few years. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
Zhejiang New Century Hotel Management saw earnings per share decrease by 1.8% last year. But it has grown its earnings per share by 42% per year over the last five years.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
It’s important to note that the P/E ratio considers the market capitalization, not the enterprise value. So it won’t reflect the advantage of cash, or disadvantage of debt. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
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).
How Does Zhejiang New Century Hotel Management’s Debt Impact Its P/E Ratio?
The extra options and safety that comes with Zhejiang New Century Hotel Management’s CN¥253m 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 Zhejiang New Century Hotel Management’s P/E Ratio
Zhejiang New Century Hotel Management’s P/E is 16.3 which is above average (10.6) in its market. Falling earnings per share is probably keeping traditional value investors away, but the net cash position means the company has time to improve: and the high P/E suggests the market thinks it will.
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.
You might be able to find a better buy than Zhejiang New Century Hotel Management. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
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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