Why Shimao Property Holdings Limited’s (HKG:813) High P/E Ratio Isn’t Necessarily A Bad Thing

Today, we’ll introduce the concept of the P/E ratio for those who are learning about investing. We’ll apply a basic P/E ratio analysis to Shimao Property Holdings Limited’s (HKG:813), to help you decide if the stock is worth further research. Shimao Property Holdings has a P/E ratio of 8.98, based on the last twelve months. That corresponds to an earnings yield of approximately 11.1%.

See our latest analysis for Shimao Property Holdings

How Do I Calculate Shimao Property Holdings’s Price To Earnings Ratio?

The formula for price to earnings is:

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

Or for Shimao Property Holdings:

P/E of 8.98 = HK$26.35 (Note: this is the share price in the reporting currency, namely, CNY ) ÷ HK$2.93 (Based on the trailing twelve months to June 2019.)

Is A High P/E Ratio Good?

A higher P/E ratio implies that investors pay a higher price for the earning power of the business. That isn’t a good or a bad thing on its own, but a high P/E means that buyers have a higher opinion of the business’s prospects, relative to stocks with a lower P/E.

Does Shimao Property Holdings Have A Relatively High Or Low P/E For Its Industry?

The P/E ratio essentially measures market expectations of a company. You can see in the image below that the average P/E (6.7) for companies in the real estate industry is lower than Shimao Property Holdings’s P/E.

SEHK:813 Price Estimation Relative to Market, December 4th 2019
SEHK:813 Price Estimation Relative to Market, December 4th 2019

Its relatively high P/E ratio indicates that Shimao Property Holdings shareholders think it will perform better than other companies in its industry classification. The market is optimistic about the future, but that doesn’t guarantee future growth. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.

How Growth Rates Impact P/E Ratios

P/E ratios primarily reflect market expectations around earnings growth rates. That’s because companies that grow earnings per share quickly will rapidly increase the ‘E’ in the equation. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. And as that P/E ratio drops, the company will look cheap, unless its share price increases.

It’s great to see that Shimao Property Holdings grew EPS by 20% in the last year. And earnings per share have improved by 4.6% annually, over the last five years. This could arguably justify a relatively high P/E ratio.

A Limitation: P/E Ratios Ignore Debt and Cash In The Bank

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. 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 Shimao Property Holdings’s Balance Sheet Tell Us?

Shimao Property Holdings’s net debt is 79% of its market cap. If you want to compare its P/E ratio to other companies, you should absolutely keep in mind it has significant borrowings.

The Verdict On Shimao Property Holdings’s P/E Ratio

Shimao Property Holdings trades on a P/E ratio of 9.0, which is below the HK market average of 10.1. While the EPS growth last year was strong, the significant debt levels reduce the number of options available to management. The low P/E ratio suggests current market expectations are muted, implying these levels of growth will not continue.

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 Shimao Property Holdings. 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 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.