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The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We’ll show how you can use Beijing Tong Ren Tang Chinese Medicine Company Limited’s (HKG:3613) P/E ratio to inform your assessment of the investment opportunity. What is Beijing Tong Ren Tang Chinese Medicine’s P/E ratio? Well, based on the last twelve months it is 21.07. That is equivalent to an earnings yield of about 4.7%.
How Do I Calculate Beijing Tong Ren Tang Chinese Medicine’s Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Beijing Tong Ren Tang Chinese Medicine:
P/E of 21.07 = HK$14.62 ÷ HK$0.69 (Based on the year to December 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
Earnings growth rates have a big influence on P/E ratios. Earnings growth means that in the future the ‘E’ will be higher. 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.
Most would be impressed by Beijing Tong Ren Tang Chinese Medicine earnings growth of 19% in the last year. And it has bolstered its earnings per share by 19% per year over the last five years. So one might expect an above average P/E ratio.
Does Beijing Tong Ren Tang Chinese Medicine Have A Relatively High Or Low P/E For Its Industry?
The P/E ratio indicates whether the market has higher or lower expectations of a company. As you can see below, Beijing Tong Ren Tang Chinese Medicine has a higher P/E than the average company (12.4) in the pharmaceuticals industry.
Beijing Tong Ren Tang Chinese Medicine’s P/E tells us that market participants think the company will perform better than its industry peers, going forward. Clearly the market expects growth, but it isn’t guaranteed. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.
Don’t Forget: The P/E Does Not Account For Debt or Bank Deposits
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. Thus, the metric does not reflect cash or debt held by the company. 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.
How Does Beijing Tong Ren Tang Chinese Medicine’s Debt Impact Its P/E Ratio?
Beijing Tong Ren Tang Chinese Medicine has net cash of HK$2.3b. This is fairly high at 19% 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 Bottom Line On Beijing Tong Ren Tang Chinese Medicine’s P/E Ratio
Beijing Tong Ren Tang Chinese Medicine has a P/E of 21.1. That’s higher than the average in the HK market, which is 10.9. Its net cash position supports a higher P/E ratio, as does its solid recent earnings growth. So it does not seem strange that the P/E is above average.
Investors have an opportunity when market expectations about a stock are wrong. People often underestimate remarkable growth — so investors can make money when fast growth is not fully appreciated. So this free report on the analyst consensus forecasts could help you make a master move on this stock.
Of course you might be able to find a better stock than Beijing Tong Ren Tang Chinese Medicine. So you may wish to see this free collection of other companies that have grown earnings strongly.
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.