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This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). To keep it practical, we’ll show how China Aerospace International Holdings Limited’s (HKG:31) P/E ratio could help you assess the value on offer. China Aerospace International Holdings has a P/E ratio of 3.78, based on the last twelve months. That is equivalent to an earnings yield of about 26%.
How Do You Calculate A P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for China Aerospace International Holdings:
P/E of 3.78 = HK$0.55 ÷ HK$0.15 (Based on the trailing twelve months 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 a good or a bad thing on its own, but a high P/E means that buyers have a higher opinion of the business’s prospects, relative to stocks with a lower P/E.
How Growth Rates Impact P/E Ratios
If earnings fall then in the future the ‘E’ will be lower. That means even if the current P/E is low, it will increase over time if the share price stays flat. A higher P/E should indicate the stock is expensive relative to others — and that may encourage shareholders to sell.
Most would be impressed by China Aerospace International Holdings earnings growth of 19% in the last year. And its annual EPS growth rate over 5 years is 5.0%. With that performance, you might expect an above average P/E ratio. Unfortunately, earnings per share are down 29% a year, over 3 years.
How Does China Aerospace International Holdings’s P/E Ratio Compare To Its Peers?
We can get an indication of market expectations by looking at the P/E ratio. We can see in the image below that the average P/E (8.2) for companies in the electronic industry is higher than China Aerospace International Holdings’s P/E.
Its relatively low P/E ratio indicates that China Aerospace International Holdings shareholders think it will struggle to do as well as other companies in its industry classification. Since the market seems unimpressed with China Aerospace International Holdings, it’s quite possible it could surprise on the upside. You should delve deeper. I like to check if company insiders have been buying or selling.
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. Thus, the metric does not reflect cash or debt held by the company. Theoretically, a business can improve its earnings (and produce a lower P/E in the future), by taking on debt (or spending its remaining cash).
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 Aerospace International Holdings’s Balance Sheet
China Aerospace International Holdings has net debt worth 36% of its market capitalization. This is enough debt that you’d have to make some adjustments before using the P/E ratio to compare it to a company with net cash.
The Bottom Line On China Aerospace International Holdings’s P/E Ratio
China Aerospace International Holdings trades on a P/E ratio of 3.8, which is below the HK market average of 10.4. The company hasn’t stretched its balance sheet, and earnings growth was good last year. If it continues to grow, then the current low P/E may prove to be unjustified.
Investors should be looking to buy stocks that the market is wrong about. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. 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 Aerospace International Holdings. 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 email@example.com.