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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 Services Corporation Limited’s (HKG:552) P/E ratio could help you assess the value on offer. What is China Communications Services’s P/E ratio? Well, based on the last twelve months it is 12.61. That corresponds to an earnings yield of approximately 7.9%.
How Do You Calculate China Communications Services’s P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share (in the reporting currency) ÷ Earnings per Share (EPS)
Or for China Communications Services:
P/E of 12.61 = CN¥5.28 (Note: this is the share price in the reporting currency, namely, CNY ) ÷ CN¥0.42 (Based on the trailing twelve months to December 2018.)
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 is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about 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.
China Communications Services increased earnings per share by 6.9% last year. And earnings per share have improved by 5.3% annually, over the last five years.
Does China Communications Services Have A Relatively High Or Low P/E For Its Industry?
We can get an indication of market expectations by looking at the P/E ratio. You can see in the image below that the average P/E (11.3) for companies in the construction industry is lower than China Communications Services’s P/E.
That means that the market expects China Communications Services will outperform other companies in its industry. Clearly the market expects growth, but it isn’t guaranteed. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.
Remember: P/E Ratios Don’t Consider The Balance Sheet
It’s important to note that the P/E ratio considers the market capitalization, not the enterprise value. In other words, it does not consider any debt or cash that the company may have on the balance sheet. 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.
China Communications Services’s Balance Sheet
China Communications Services has net cash of CN¥21b. This is fairly high at 57% 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 China Communications Services’s P/E Ratio
China Communications Services trades on a P/E ratio of 12.6, which is above the HK market average of 10.9. Earnings improved over the last year. Also positive, the relatively strong balance sheet will allow for investment in growth — and the P/E indicates shareholders that will happen!
Investors should be looking to buy stocks that the market is wrong about. As value investor Benjamin Graham famously said, ‘In the short run, the market is a voting machine but in the long run, it is a weighing machine.’ 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.
But note: China Communications Services may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
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 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.