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The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). To keep it practical, we’ll show how China Oriental Group Company Limited’s (HKG:581) P/E ratio could help you assess the value on offer. China Oriental Group has a P/E ratio of 2.73, based on the last twelve months. That means that at current prices, buyers pay HK$2.73 for every HK$1 in trailing yearly profits.
How Do You Calculate China Oriental Group’s P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price (in reporting currency) ÷ Earnings per Share (EPS)
Or for China Oriental Group:
P/E of 2.73 = CN¥4.5 (Note: this is the share price in the reporting currency, namely, CNY ) ÷ CN¥1.65 (Based on the year to June 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 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
Earnings growth rates have a big influence on P/E ratios. 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. Then, a lower P/E should attract more buyers, pushing the share price up.
Notably, China Oriental Group grew EPS by a whopping 154% in the last year. And it has bolstered its earnings per share by 76% per year over the last five years. I’d therefore be a little surprised if its P/E ratio was not relatively high.
How Does China Oriental Group’s P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. The image below shows that China Oriental Group has a lower P/E than the average (8.5) P/E for companies in the metals and mining industry.
Its relatively low P/E ratio indicates that China Oriental Group shareholders think it will struggle to do as well as other companies in its industry classification. Since the market seems unimpressed with China Oriental 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.
Remember: P/E Ratios Don’t Consider The Balance Sheet
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.
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.
China Oriental Group’s Balance Sheet
The extra options and safety that comes with China Oriental Group’s CN¥4.4b net cash position means that it deserves a higher P/E than it would if it had a lot of net debt.
The Bottom Line On China Oriental Group’s P/E Ratio
China Oriental Group has a P/E of 2.7. That’s below the average in the HK market, which is 10.7. The net cash position gives plenty of options to the business, and the recent improvement in EPS is good to see. One might conclude that the market is a bit pessimistic, given the low P/E ratio.
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.
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 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.