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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 China Ludao Technology Company Limited’s (HKG:2023) P/E ratio to inform your assessment of the investment opportunity. China Ludao Technology has a price to earnings ratio of 21.29, based on the last twelve months. In other words, at today’s prices, investors are paying HK$21.29 for every HK$1 in prior year profit.
How Do I Calculate A Price To Earnings 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 Ludao Technology:
P/E of 21.29 = CN¥0.98 (Note: this is the share price in the reporting currency, namely, CNY ) ÷ CN¥0.046 (Based on the year to June 2018.)
Is A High P/E 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
P/E ratios primarily reflect market expectations around earnings growth rates. When earnings grow, the ‘E’ increases, over time. 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.
China Ludao Technology’s earnings per share grew by -2.6% in the last twelve months. And its annual EPS growth rate over 3 years is 36%. But earnings per share are down 3.9% per year over the last five years.
How Does China Ludao Technology’s P/E Ratio Compare To Its Peers?
The P/E ratio indicates whether the market has higher or lower expectations of a company. The image below shows that China Ludao Technology has a lower P/E than the average (27.8) P/E for companies in the household products industry.
Its relatively low P/E ratio indicates that China Ludao Technology shareholders think it will struggle to do as well as other companies in its industry classification. Since the market seems unimpressed with China Ludao Technology, it’s quite possible it could surprise on the upside. 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
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. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
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.
Is Debt Impacting China Ludao Technology’s P/E?
China Ludao Technology’s net debt is 18% of its market cap. That’s enough debt to impact the P/E ratio a little; so keep it in mind if you’re comparing it to companies without debt.
The Verdict On China Ludao Technology’s P/E Ratio
China Ludao Technology’s P/E is 21.3 which is above average (10.5) in the HK market. With modest debt relative to its size, and modest earnings growth, the market is likely expecting sustained long-term growth, if not a near-term improvement.
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. Although we don’t have analyst forecasts, you could get a better understanding of its growth by checking out this more detailed historical graph of earnings, revenue and cash flow.
You might be able to find a better buy than China Ludao Technology. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
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 firstname.lastname@example.org.