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 Datang Environment Industry Group Co., Ltd.’s (HKG:1272) P/E ratio to inform your assessment of the investment opportunity. Datang Environment Industry Group has a P/E ratio of 6.32, based on the last twelve months. That means that at current prices, buyers pay HK$6.32 for every HK$1 in trailing yearly profits.
How Do I Calculate A 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 Datang Environment Industry Group:
P/E of 6.32 = CN¥1.63 (Note: this is the share price in the reporting currency, namely, CNY ) ÷ CN¥0.26 (Based on the year 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. 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
Companies that shrink earnings per share quickly will rapidly decrease the ‘E’ in the equation. That means unless the share price falls, the P/E will increase in a few years. A higher P/E should indicate the stock is expensive relative to others — and that may encourage shareholders to sell.
Datang Environment Industry Group’s earnings per share fell by 12% in the last twelve months. And EPS is down 13% a year, over the last 5 years. This might lead to muted expectations.
How Does Datang Environment Industry Group’s P/E Ratio Compare To Its Peers?
The P/E ratio indicates whether the market has higher or lower expectations of a company. We can see in the image below that the average P/E (12.8) for companies in the commercial services industry is higher than Datang Environment Industry Group’s P/E.
Datang Environment Industry Group’s P/E tells us that market participants think it will not fare as well as its peers in the same industry. Since the market seems unimpressed with Datang Environment Industry Group, it’s quite possible it could surprise on the upside. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.
Don’t Forget: The P/E Does Not Account For Debt or Bank Deposits
It’s important to note that the P/E ratio considers the market capitalization, not the enterprise value. 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.
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).
How Does Datang Environment Industry Group’s Debt Impact Its P/E Ratio?
Datang Environment Industry Group’s net debt is 66% of its market cap. This is a reasonably significant level of debt — all else being equal you’d expect a much lower P/E than if it had net cash.
The Verdict On Datang Environment Industry Group’s P/E Ratio
Datang Environment Industry Group trades on a P/E ratio of 6.3, 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 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. We don’t have analyst forecasts, but shareholders might want to examine this detailed historical graph of earnings, revenue and cash flow.
But note: Datang Environment Industry 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).
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.