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 China Mobile Limited’s (HKG:941) P/E ratio to inform your assessment of the investment opportunity. China Mobile has a P/E ratio of 11.66, based on the last twelve months. That corresponds to an earnings yield of approximately 8.6%.
How Do You Calculate China Mobile’s P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Share Price (in reporting currency) ÷ Earnings per Share (EPS)
Or for China Mobile:
P/E of 11.66 = CN¥66.74 (Note: this is the share price in the reporting currency, namely, CNY ) ÷ CN¥5.72 (Based on the trailing twelve months to September 2018.)
Is A High P/E Ratio Good?
A higher P/E ratio implies that investors pay a higher price for the earning power of the business. 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
Probably the most important factor in determining what P/E a company trades on is the earnings growth. 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. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
China Mobile’s earnings per share grew by -4.1% in the last twelve months. And it has improved its earnings per share by 2.8% per year over the last three years. Unfortunately, earnings per share are down 1.3% a year, over 5 years.
How Does China Mobile’s P/E Ratio Compare To Its Peers?
We can get an indication of market expectations by looking at the P/E ratio. If you look at the image below, you can see China Mobile has a lower P/E than the average (15) in the wireless telecom industry classification.
Its relatively low P/E ratio indicates that China Mobile shareholders think it will struggle to do as well as other companies in its industry classification. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. You should delve deeper. I like to check if company insiders have been buying or selling.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
Don’t forget that the P/E ratio considers market capitalization. In other words, it does not consider any debt or cash that the company may have on the balance sheet. 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.
China Mobile’s Balance Sheet
Since China Mobile holds net cash of CN¥469b, it can spend on growth, justifying a higher P/E ratio than otherwise.
The Verdict On China Mobile’s P/E Ratio
China Mobile trades on a P/E ratio of 11.7, which is above the HK market average of 10.6. Earnings improved over the last year. And the net cash position provides the company with multiple options. The high P/E suggests the market thinks further growth will come.
When the market is wrong about a stock, it gives savvy investors an opportunity. 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 they key to an excellent investment decision.
Of course you might be able to find a better stock than China Mobile. So you may wish to see this free collection of other companies that have grown earnings strongly.
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.