The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We’ll look at China Renewable Energy Investment Limited’s (HKG:987) P/E ratio and reflect on what it tells us about the company’s share price. What is China Renewable Energy Investment’s P/E ratio? Well, based on the last twelve months it is 9.87. That corresponds to an earnings yield of approximately 10%.
How Do You Calculate A P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for China Renewable Energy Investment:
P/E of 9.87 = HK$0.19 ÷ HK$0.019 (Based on the year to June 2019.)
Is A High P/E 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 China Renewable Energy Investment’s P/E Ratio Compare To Its Peers?
The P/E ratio indicates whether the market has higher or lower expectations of a company. As you can see below China Renewable Energy Investment has a P/E ratio that is fairly close for the average for the renewable energy industry, which is 9.4.
China Renewable Energy Investment’s P/E tells us that market participants think its prospects are roughly in line with its industry.
How Growth Rates Impact P/E Ratios
Companies that shrink earnings per share quickly will rapidly decrease the ‘E’ in the equation. Therefore, even if you pay a low multiple of earnings now, that multiple will become higher in the future. A higher P/E should indicate the stock is expensive relative to others — and that may encourage shareholders to sell.
China Renewable Energy Investment saw earnings per share decrease by 44% last year. But it has grown its earnings per share by 27% per year over the last five years. And it has shrunk its earnings per share by 2.2% per year over the last three years. This growth rate might warrant a low P/E ratio.
Don’t Forget: The P/E Does Not Account For Debt or Bank Deposits
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. So it won’t reflect the advantage of cash, or disadvantage of debt. 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 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.
So What Does China Renewable Energy Investment’s Balance Sheet Tell Us?
China Renewable Energy Investment has net debt worth a very significant 117% of its market capitalization. This level of debt justifies a relatively low P/E, so remain cognizant of the debt, if you’re comparing it to other stocks.
The Verdict On China Renewable Energy Investment’s P/E Ratio
China Renewable Energy Investment’s P/E is 9.9 which is about average (10.5) in the HK market. With significant debt and no EPS growth last year, the P/E suggests shareholders are expecting higher profit in the future.
Investors have an opportunity when market expectations about a stock are wrong. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. We don’t have analyst forecasts, but shareholders might want to examine this detailed historical graph of earnings, revenue and cash flow.
But note: China Renewable Energy Investment 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).
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.