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This article is written for those who want to get better at using price to earnings ratios (P/E ratios). To keep it practical, we’ll show how China Communications Construction Company Limited’s (HKG:1800) P/E ratio could help you assess the value on offer. What is China Communications Construction’s P/E ratio? Well, based on the last twelve months it is 5.16. That means that at current prices, buyers pay HK$5.16 for every HK$1 in trailing yearly profits.
How Do I Calculate China Communications Construction’s Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price (in reporting currency) ÷ Earnings per Share (EPS)
Or for China Communications Construction:
P/E of 5.16 = CN¥6.11 (Note: this is the share price in the reporting currency, namely, CNY ) ÷ CN¥1.18 (Based on the year to March 2019.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio means that investors are paying a higher price for each HK$1 of company earnings. 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.
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. 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 Communications Construction saw earnings per share decrease by 3.8% last year. But over the longer term (5 years) earnings per share have increased by 9.6%.
How Does China Communications Construction’s P/E Ratio Compare To Its Peers?
One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. If you look at the image below, you can see China Communications Construction has a lower P/E than the average (10.8) in the construction industry classification.
This suggests that market participants think China Communications Construction will underperform other companies in its industry.
Remember: P/E Ratios Don’t Consider The Balance Sheet
Don’t forget that the P/E ratio considers market capitalization. So it won’t reflect the advantage of cash, or disadvantage of debt. 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).
Spending on growth might be good or bad a few years later, but the point is that the P/E ratio does not account for the option (or lack thereof).
China Communications Construction’s Balance Sheet
China Communications Construction has net debt worth a very significant 116% of its market capitalization. This level of debt justifies a relatively low P/E, so remain cognizant of the debt, if you’re comparing it to other stocks.
The Bottom Line On China Communications Construction’s P/E Ratio
China Communications Construction trades on a P/E ratio of 5.2, which is below the HK market average of 11. When you consider that the company has significant debt, and didn’t grow EPS last year, it isn’t surprising that the market has muted expectations.
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 China Communications Construction. 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.