The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). To keep it practical, we'll show how BOC Aviation Limited's (HKG:2588) P/E ratio could help you assess the value on offer. Looking at earnings over the last twelve months, BOC Aviation has a P/E ratio of 10.54. In other words, at today's prices, investors are paying HK$10.54 for every HK$1 in prior year profit.
How Do I Calculate BOC Aviation'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 BOC Aviation:
P/E of 10.54 = HK$9.79 (Note: this is the share price in the reporting currency, namely, USD ) ÷ HK$0.93 (Based on the year to June 2019.)
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.
Does BOC Aviation 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 BOC Aviation has a P/E ratio that is roughly in line with the trade distributors industry average (9.9).
Its P/E ratio suggests that BOC Aviation shareholders think that in the future it will perform about the same as other companies in its industry classification.
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. Then, a lower P/E should attract more buyers, pushing the share price up.
BOC Aviation had pretty flat EPS growth in the last year. But it has grown its earnings per share by 13% per year over the last three years. The company could impress by growing EPS, in the future. Checking factors such as director buying and selling. could help you form your own view on if that will happen.
Remember: P/E Ratios Don't Consider The Balance Sheet
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. That means it doesn't take debt or cash into account. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.
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 BOC Aviation's P/E?
Net debt totals a substantial 191% of BOC Aviation's market cap. If you want to compare its P/E ratio to other companies, you must keep in mind that these debt levels would usually warrant a relatively low P/E.
The Verdict On BOC Aviation's P/E Ratio
BOC Aviation has a P/E of 10.5. That's around the same as the average in the HK market, which is 10.5. It has significant debt, though the market seems to take confidence from recent earnings growth.
Investors have an opportunity when market expectations about a stock are wrong. 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 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.
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If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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.