Why PetroChina Company Limited’s (HKG:857) High P/E Ratio Isn’t Necessarily A Bad Thing

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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 PetroChina Company Limited’s (HKG:857) P/E ratio to inform your assessment of the investment opportunity. PetroChina has a price to earnings ratio of 15.49, based on the last twelve months. That corresponds to an earnings yield of approximately 6.5%.

View our latest analysis for PetroChina

How Do You Calculate PetroChina’s P/E Ratio?

The formula for P/E is:

Price to Earnings Ratio = Share Price (in reporting currency) ÷ Earnings per Share (EPS)

Or for PetroChina:

P/E of 15.49 = CN¥4.53 (Note: this is the share price in the reporting currency, namely, CNY ) ÷ CN¥0.29 (Based on the trailing twelve months 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. That isn’t a good or a bad thing on its own, but a high P/E means that buyers have a higher opinion of the business’s prospects, relative to stocks with a lower P/E.

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. When earnings grow, the ‘E’ increases, over time. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. A lower P/E should indicate the stock is cheap relative to others — and that may attract buyers.

PetroChina increased earnings per share by a whopping 137% last year. And its annual EPS growth rate over 3 years is 17%. With that performance, I would expect it to have an above average P/E ratio. But earnings per share are down 41% per year over the last five years.

How Does PetroChina’s P/E Ratio Compare To Its Peers?

The P/E ratio indicates whether the market has higher or lower expectations of a company. As you can see below, PetroChina has a higher P/E than the average company (11.6) in the oil and gas industry.

SEHK:857 Price Estimation Relative to Market, February 22nd 2019
SEHK:857 Price Estimation Relative to Market, February 22nd 2019

PetroChina’s P/E tells us that market participants think the company will perform better than its industry peers, going forward. The market is optimistic about the future, but that doesn’t guarantee future growth. So investors should delve deeper. I like to check if company insiders have been buying or selling.

Remember: P/E Ratios Don’t Consider The Balance Sheet

The ‘Price’ in P/E reflects the market capitalization of the company. In other words, it does not consider any debt or cash that the company may have on the balance sheet. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.

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.

Is Debt Impacting PetroChina’s P/E?

Net debt totals 20% of PetroChina’s market cap. It would probably deserve a higher P/E ratio if it was net cash, since it would have more options for growth.

The Verdict On PetroChina’s P/E Ratio

PetroChina trades on a P/E ratio of 15.5, which is above the HK market average of 10.7. While the company does use modest debt, its recent earnings growth is impressive. Therefore it seems reasonable that the market would have relatively high expectations of the company

Investors have an opportunity when market expectations about a stock are wrong. 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 visual report on analyst forecasts could hold the key to an excellent investment decision.

But note: PetroChina 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 editorial-team@simplywallst.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.