Should You Be Tempted To Sell China Zheshang Bank Co., Ltd (HKG:2016) Because Of Its P/E Ratio?

Today, we’ll introduce the concept of the P/E ratio for those who are learning about investing. We’ll look at China Zheshang Bank Co., Ltd’s (HKG:2016) P/E ratio and reflect on what it tells us about the company’s share price. Based on the last twelve months, China Zheshang Bank’s P/E ratio is 6.44. That corresponds to an earnings yield of approximately 16%.

View our latest analysis for China Zheshang Bank

How Do I Calculate China Zheshang Bank’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 China Zheshang Bank:

P/E of 6.44 = CN¥4.01 (Note: this is the share price in the reporting currency, namely, CNY ) ÷ CN¥0.62 (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 HK$1 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 Zheshang Bank 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. You can see in the image below that the average P/E (6.2) for companies in the banks industry is roughly the same as China Zheshang Bank’s P/E.

SEHK:2016 Price Estimation Relative to Market, September 6th 2019
SEHK:2016 Price Estimation Relative to Market, September 6th 2019

That indicates that the market expects China Zheshang Bank will perform roughly in line with other companies in its industry.

How Growth Rates Impact P/E Ratios

Earnings growth rates have a big influence on P/E ratios. 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. Then, a lower P/E should attract more buyers, pushing the share price up.

China Zheshang Bank increased earnings per share by 3.1% last year. And its annual EPS growth rate over 3 years is 4.2%.

Don’t Forget: The P/E Does Not Account For Debt or Bank Deposits

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. The exact same company would hypothetically deserve a higher P/E ratio if it had a strong balance sheet, than if it had a weak one with lots of debt, because a cashed up company can spend on 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.

Is Debt Impacting China Zheshang Bank’s P/E?

China Zheshang Bank has net debt worth a very significant 207% of its market capitalization. If you want to compare its P/E ratio to other companies, you must keep in mind that these debt levels would usually warrant a relatively low P/E.

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

China Zheshang Bank has a P/E of 6.4. That’s below the average in the HK market, which is 10.5. The meaningful debt load is probably contributing to low expectations, even though it has improved earnings recently.

Investors should be looking to buy stocks that the market is wrong about. 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. We don’t have analyst forecasts, but shareholders might want to examine this detailed historical graph of earnings, revenue and cash flow.

You might be able to find a better buy than China Zheshang Bank. 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).

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 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. Thank you for reading.