Should You Be Tempted To Sell SINOPEC Engineering (Group) Co Ltd (HKG:2386) Because Of Its P/E Ratio?

This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We’ll show how you can use SINOPEC Engineering (Group) Co Ltd’s (HKG:2386) P/E ratio to inform your assessment of the investment opportunity. SINOPEC Engineering (Group) has a price to earnings ratio of 21.22, based on the last twelve months. That corresponds to an earnings yield of approximately 4.7%.

Check out our latest analysis for SINOPEC Engineering (Group)

How Do I Calculate SINOPEC Engineering (Group)’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 SINOPEC Engineering (Group):

P/E of 21.22 = CN¥6.72 (Note: this is the share price in the reporting currency, namely, CNY ) ÷ CN¥0.32 (Based on the trailing twelve months to June 2018.)

Is A High P/E Ratio Good?

A higher P/E ratio means that investors are paying a higher price for each HK$1 of company earnings. 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

If earnings fall then in the future the ‘E’ will be lower. Therefore, even if you pay a low multiple of earnings now, that multiple will become higher in the future. So while a stock may look cheap based on past earnings, it could be expensive based on future earnings.

SINOPEC Engineering (Group) shrunk earnings per share by 1.7% last year. And it has shrunk its earnings per share by 26% per year over the last five years. So you wouldn’t expect a very high P/E.

How Does SINOPEC Engineering (Group)’s P/E Ratio Compare To Its Peers?

The P/E ratio essentially measures market expectations of a company. The image below shows that SINOPEC Engineering (Group) has a higher P/E than the average (11.5) P/E for companies in the construction industry.

SEHK:2386 PE PEG Gauge November 12th 18
SEHK:2386 PE PEG Gauge November 12th 18

That means that the market expects SINOPEC Engineering (Group) will outperform other companies in its industry. Shareholders are clearly optimistic, but the future is always uncertain. So investors should delve deeper. I like to check if company insiders have been buying or selling.

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. 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 SINOPEC Engineering (Group)’s Debt Impact Its P/E Ratio?

SINOPEC Engineering (Group) has net cash of CN¥13.9b. 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 SINOPEC Engineering (Group)’s P/E Ratio

SINOPEC Engineering (Group)’s P/E is 21.2 which is above average (10.7) in the HK market. Falling earnings per share is probably keeping traditional value investors away, but the healthy balance sheet means the company retains potential for future growth. If fails to eventuate, the current high P/E could prove to be temporary, as the share price falls.

Investors should be looking to buy stocks that the market is wrong about. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. 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 SINOPEC Engineering (Group). So you may wish to see this free collection of other companies that have grown earnings strongly.

To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.