The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We’ll look at China Resources Medical Holdings Company Limited’s (HKG:1515) P/E ratio and reflect on what it tells us about the company’s share price. Looking at earnings over the last twelve months, China Resources Medical Holdings has a P/E ratio of 15.32. That means that at current prices, buyers pay HK$15.32 for every HK$1 in trailing yearly profits.
How Do You Calculate A 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 China Resources Medical Holdings:
P/E of 15.32 = CN¥5.21 (Note: this is the share price in the reporting currency, namely, CNY ) ÷ CN¥0.34 (Based on the year to December 2018.)
Is A High P/E Ratio Good?
A higher P/E ratio means that buyers have to pay a higher price for each HK$1 the company has earned over the last year. That isn’t necessarily good or bad, but a high P/E implies relatively high expectations of what a company can achieve in 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. That’s because companies that grow earnings per share quickly will rapidly increase the ‘E’ in the equation. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
China Resources Medical Holdings saw earnings per share improve by -3.2% last year. And earnings per share have improved by 17% annually, over the last five years.
How Does China Resources Medical Holdings’s P/E Ratio Compare To Its Peers?
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 China Resources Medical Holdings has a lower P/E than the average (18.3) P/E for companies in the healthcare industry.
This suggests that market participants think China Resources Medical Holdings will underperform other companies in its industry. Since the market seems unimpressed with China Resources Medical Holdings, 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. 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 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 Resources Medical Holdings’s Balance Sheet
China Resources Medical Holdings has net cash of CN¥1.4b. This is fairly high at 21% 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 Verdict On China Resources Medical Holdings’s P/E Ratio
China Resources Medical Holdings has a P/E of 15.3. That’s higher than the average in the HK market, which is 12.1. EPS was up modestly better over the last twelve months. And the net cash position provides the company with multiple options. The high P/E suggests the market thinks further growth will come.
When the market is wrong about a stock, it gives savvy investors an opportunity. 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 visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.
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.
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.