This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). To keep it practical, we’ll show how BAIC Motor Corporation Limited’s (HKG:1958) P/E ratio could help you assess the value on offer. BAIC Motor has a price to earnings ratio of 8.21, based on the last twelve months. That corresponds to an earnings yield of approximately 12%.
How Do You Calculate BAIC Motor’s P/E 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 BAIC Motor:
P/E of 8.21 = CN¥4.35 (Note: this is the share price in the reporting currency, namely, CNY ) ÷ CN¥0.53 (Based on the year to June 2018.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio implies that investors pay a higher price for the earning power of the business. 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 Growth Rates Impact P/E Ratios
Companies that shrink earnings per share quickly will rapidly decrease the ‘E’ in the equation. 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.
BAIC Motor shrunk earnings per share by 19% over the last year. And over the longer term (5 years) earnings per share have decreased 1.5% annually. This could justify a pessimistic P/E.
How Does BAIC Motor’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 BAIC Motor has a lower P/E than the average (8.9) P/E for companies in the auto industry.
This suggests that market participants think BAIC Motor will underperform other companies in its industry. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and selling.
Remember: P/E Ratios Don’t Consider The Balance Sheet
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. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
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 BAIC Motor’s P/E?
BAIC Motor has net cash of CN¥12b. That should lead to a higher P/E than if it did have debt, because its strong balance sheets gives it more options.
The Verdict On BAIC Motor’s P/E Ratio
BAIC Motor has a P/E of 8.2. That’s below the average in the HK market, which is 10.7. Falling earnings per share are likely to be keeping potential buyers away, but the net cash position means the company has time to improve: if so, the low P/E could be an opportunity.
Investors have an opportunity when market expectations about a stock are wrong. 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. 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.
Of course you might be able to find a better stock than BAIC Motor. So you may wish to see this free collection of other companies that have grown earnings strongly.
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.