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Today, we’ll introduce the concept of the P/E ratio for those who are learning about investing. To keep it practical, we’ll show how Hebei Construction Group Corporation Limited’s (HKG:1727) P/E ratio could help you assess the value on offer. What is Hebei Construction Group’s P/E ratio? Well, based on the last twelve months it is 9.23. That means that at current prices, buyers pay HK$9.23 for every HK$1 in trailing yearly profits.
How Do You Calculate Hebei Construction Group’s P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price (in reporting currency) ÷ Earnings per Share (EPS)
Or for Hebei Construction Group:
P/E of 9.23 = CN¥5.83 (Note: this is the share price in the reporting currency, namely, CNY ) ÷ CN¥0.63 (Based on the year to December 2018.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio means that buyers have to pay a higher price for each HK$1 the company has earned over the last year. 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 Growth Rates Impact P/E Ratios
Probably the most important factor in determining what P/E a company trades on is the earnings growth. Earnings growth means that in the future the ‘E’ will be higher. And in that case, the P/E ratio itself will drop rather quickly. Then, a lower P/E should attract more buyers, pushing the share price up.
Hebei Construction Group saw earnings per share decrease by 19% last year. But EPS is up 6.1% over the last 5 years.
Does Hebei Construction Group Have A Relatively High Or Low P/E For Its Industry?
One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. The image below shows that Hebei Construction Group has a lower P/E than the average (11.1) P/E for companies in the construction industry.
Its relatively low P/E ratio indicates that Hebei Construction Group shareholders think it will struggle to do as well as other companies in its industry classification. Since the market seems unimpressed with Hebei Construction Group, it’s quite possible it could surprise on the upside. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
Don’t forget that the P/E ratio considers market capitalization. That means it doesn’t take debt or cash into account. 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.
How Does Hebei Construction Group’s Debt Impact Its P/E Ratio?
Hebei Construction Group has net cash of CN¥5.7b. This is fairly high at 55% of its market capitalization. That might mean balance sheet strength is important to the business, but should also help push the P/E a bit higher than it would otherwise be.
The Bottom Line On Hebei Construction Group’s P/E Ratio
Hebei Construction Group’s P/E is 9.2 which is below average (10.9) in the HK market. Falling earnings per share are likely to be keeping potential buyers away, the healthy balance sheet means the company retains potential for future growth. If that occurs, the current low P/E could prove to be temporary.
When the market is wrong about a stock, it gives savvy investors an opportunity. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. So this free report on the analyst consensus forecasts could help you make a master move on this stock.
You might be able to find a better buy than Hebei Construction Group. 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 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.