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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 look at Asiainfo Technologies Limited’s (HKG:1675) P/E ratio and reflect on what it tells us about the company’s share price. Asiainfo Technologies has a price to earnings ratio of 24.29, based on the last twelve months. That means that at current prices, buyers pay HK$24.29 for every HK$1 in trailing yearly profits.
How Do I Calculate A Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Share Price (in reporting currency) ÷ Earnings per Share (EPS)
Or for Asiainfo Technologies:
P/E of 24.29 = CN¥7.93 (Note: this is the share price in the reporting currency, namely, CNY ) ÷ CN¥0.33 (Based on the year to December 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 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
Companies that shrink earnings per share quickly will rapidly decrease the ‘E’ in the equation. That means even if the current P/E is low, it will increase over time if the share price stays flat. So while a stock may look cheap based on past earnings, it could be expensive based on future earnings.
Asiainfo Technologies saw earnings per share decrease by 40% last year. And EPS is down 8.4% a year, over the last 5 years. This might lead to muted expectations.
Does Asiainfo Technologies Have A Relatively High Or Low P/E For Its Industry?
We can get an indication of market expectations by looking at the P/E ratio. The image below shows that Asiainfo Technologies has a higher P/E than the average (12.1) P/E for companies in the software industry.
Its relatively high P/E ratio indicates that Asiainfo Technologies shareholders think it will perform better than other companies in its industry classification. The market is optimistic about the future, but that doesn’t guarantee future growth. 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. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.
While growth expenditure doesn’t always pay off, the point is that it is a good option to have; but one that the P/E ratio ignores.
How Does Asiainfo Technologies’s Debt Impact Its P/E Ratio?
Since Asiainfo Technologies holds net cash of CN¥116m, it can spend on growth, justifying a higher P/E ratio than otherwise.
The Verdict On Asiainfo Technologies’s P/E Ratio
Asiainfo Technologies’s P/E is 24.3 which is above average (10.7) in the HK market. The recent drop in earnings per share might keep value investors away, but the healthy balance sheet means the company retains potential for future growth. If fails to eventuate, the current high P/E could prove to be temporary, as the share price falls.
Investors should be looking to buy stocks that the market is wrong about. 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 be able to find a better stock than Asiainfo Technologies. 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 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.