This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We’ll look at China Telecom Corporation Limited’s (HKG:728) P/E ratio and reflect on what it tells us about the company’s share price. China Telecom has a P/E ratio of 12.14, based on the last twelve months. That corresponds to an earnings yield of approximately 8.2%.
How Do I Calculate China Telecom’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 Telecom:
P/E of 12.14 = CN¥3.23 (Note: this is the share price in the reporting currency, namely, CNY ) ÷ CN¥0.27 (Based on the trailing twelve months to June 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 China Telecom’s P/E Ratio Compare To Its Peers?
We can get an indication of market expectations by looking at the P/E ratio. The image below shows that China Telecom has a P/E ratio that is roughly in line with the telecom industry average (12.1).
Its P/E ratio suggests that China Telecom 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
P/E ratios primarily reflect market expectations around earnings growth rates. If earnings are growing quickly, then the ‘E’ in the equation will increase faster than it would otherwise. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. A lower P/E should indicate the stock is cheap relative to others — and that may attract buyers.
China Telecom saw earnings per share improve by -9.8% last year. And it has bolstered its earnings per share by 2.8% per year over the last five years.
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. 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).
While growth expenditure doesn’t always pay off, the point is that it is a good option to have; but one that the P/E ratio ignores.
China Telecom’s Balance Sheet
China Telecom has net debt worth 21% of its market capitalization. That’s enough debt to impact the P/E ratio a little; so keep it in mind if you’re comparing it to companies without debt.
The Verdict On China Telecom’s P/E Ratio
China Telecom has a P/E of 12.1. That’s higher than the average in its market, which is 10.4. Given the debt is only modest, and earnings are already moving in the right direction, it’s not surprising that the market expects continued improvement.
When the market is wrong about a stock, it gives savvy investors an opportunity. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. 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 China Telecom. 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 firstname.lastname@example.org. 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.