This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). To keep it practical, we’ll show how Zhengzhou Coal Mining Machinery Group Company Limited’s (HKG:564) P/E ratio could help you assess the value on offer. Zhengzhou Coal Mining Machinery Group has a P/E ratio of 8.67, based on the last twelve months. That corresponds to an earnings yield of approximately 12%.
How Do You Calculate Zhengzhou Coal Mining Machinery Group’s P/E 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 Zhengzhou Coal Mining Machinery Group:
P/E of 8.67 = CN¥3.26 (Note: this is the share price in the reporting currency, namely, CNY ) ÷ CN¥0.38 (Based on the year to September 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. 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
P/E ratios primarily reflect market expectations around earnings growth rates. Earnings growth means that in the future the ‘E’ will be higher. That means even if the current P/E is high, it will reduce over time if the share price stays flat. Then, a lower P/E should attract more buyers, pushing the share price up.
Notably, Zhengzhou Coal Mining Machinery Group grew EPS by a whopping 152% in the last year. And it has improved its earnings per share by 93% per year over the last three years. With that performance, I would expect it to have an above average P/E ratio. But earnings per share are down 22% per year over the last five years.
How Does Zhengzhou Coal Mining Machinery Group’s P/E Ratio Compare To Its Peers?
We can get an indication of market expectations by looking at the P/E ratio. The image below shows that Zhengzhou Coal Mining Machinery Group has a lower P/E than the average (9.4) P/E for companies in the machinery industry.
Its relatively low P/E ratio indicates that Zhengzhou Coal Mining Machinery Group shareholders think it will struggle to do as well as other companies in its industry classification. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and selling.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
Don’t forget that the P/E ratio considers market capitalization. Thus, the metric does not reflect cash or debt held by the company. 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.
How Does Zhengzhou Coal Mining Machinery Group’s Debt Impact Its P/E Ratio?
Zhengzhou Coal Mining Machinery Group has net debt worth just 9.3% of its market capitalization. The market might award it a higher P/E ratio if it had net cash, but its unlikely this low level of net borrowing is having a big impact on the P/E multiple.
The Verdict On Zhengzhou Coal Mining Machinery Group’s P/E Ratio
Zhengzhou Coal Mining Machinery Group trades on a P/E ratio of 8.7, which is below the HK market average of 10.7. The EPS growth last year was strong, and debt levels are quite reasonable. If it continues to grow, then the current low P/E may prove to be unjustified. Because analysts are predicting more growth in the future, one might have expected to see a higher P/E ratio. You can taker closer look at the fundamentals, here.
Investors should be looking to buy stocks that the market is wrong about. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. 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: Zhengzhou Coal Mining Machinery Group 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).
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 email@example.com.