The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We’ll show how you can use BYD Company Limited’s (HKG:1211) P/E ratio to inform your assessment of the investment opportunity. BYD has a P/E ratio of 46.11, based on the last twelve months. That means that at current prices, buyers pay HK$46.11 for every HK$1 in trailing yearly profits.
How Do I Calculate BYD’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 BYD:
P/E of 46.11 = CN¥43.938 ÷ CN¥0.953 (Based on the trailing twelve months to September 2019.)
(Note: the above calculation uses the share price in the reporting currency, namely CNY and the calculation results may not be precise due to rounding.)
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. 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.
How Does BYD’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 BYD has a significantly higher P/E than the average (10.4) P/E for companies in the auto industry.
BYD’s P/E tells us that market participants think the company will perform better than its industry peers, going forward. The market is optimistic about the future, but that doesn’t guarantee future growth. So investors should delve deeper. I like to check if company insiders have been buying or selling.
How Growth Rates Impact P/E Ratios
When earnings fall, the ‘E’ decreases, over time. That means unless the share price falls, the P/E will increase in a few years. Then, a higher P/E might scare off shareholders, pushing the share price down.
BYD’s earnings per share grew by -4.1% in the last twelve months. And its annual EPS growth rate over 5 years is 37%. In contrast, EPS has decreased by 18%, annually, over 3 years.
Don’t Forget: The P/E Does Not Account For Debt or Bank Deposits
Don’t forget that the P/E ratio considers market capitalization. In other words, it does not consider any debt or cash that the company may have on the balance sheet. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
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.
Is Debt Impacting BYD’s P/E?
BYD has net debt equal to 42% of its market cap. While that’s enough to warrant consideration, it doesn’t really concern us.
The Bottom Line On BYD’s P/E Ratio
BYD has a P/E of 46.1. That’s significantly higher than the average in its market, which is 9.7. 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.
Investors should be looking to buy stocks that the market is wrong about. 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 report on the analyst consensus forecasts could help you make a master move on this stock.
Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.
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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