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 Tianjin Tianbao Energy Co., Ltd.’s (HKG:1671) P/E ratio to inform your assessment of the investment opportunity. Based on the last twelve months, Tianjin Tianbao Energy’s P/E ratio is 10. That corresponds to an earnings yield of approximately 10%.
How Do You Calculate A P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share (in the reporting currency) ÷ Earnings per Share (EPS)
Or for Tianjin Tianbao Energy:
P/E of 10 = CN¥1.8 (Note: this is the share price in the reporting currency, namely, CNY ) ÷ CN¥0.18 (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. All else being equal, it’s better to pay a low price — but as Warren Buffett said, ‘It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.’
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. A higher P/E should indicate the stock is expensive relative to others — and that may encourage shareholders to sell.
Tianjin Tianbao Energy shrunk earnings per share by 31% over the last year. And EPS is down 21% a year, over the last 5 years. This could justify a pessimistic P/E.
How Does Tianjin Tianbao Energy’s P/E Ratio Compare To Its Peers?
The P/E ratio indicates whether the market has higher or lower expectations of a company. If you look at the image below, you can see Tianjin Tianbao Energy has a lower P/E than the average (15.3) in the electric utilities industry classification.
Its relatively low P/E ratio indicates that Tianjin Tianbao Energy 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. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.
Don’t Forget: The P/E Does Not Account For Debt or Bank Deposits
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. 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.
Tianjin Tianbao Energy’s Balance Sheet
The extra options and safety that comes with Tianjin Tianbao Energy’s CN¥140m net cash position means that it deserves a higher P/E than it would if it had a lot of net debt.
The Verdict On Tianjin Tianbao Energy’s P/E Ratio
Tianjin Tianbao Energy trades on a P/E ratio of 10, which is below the HK market average of 11.4. The recent drop in earnings per share would almost certainly temper expectations, the healthy balance sheet means the company retains potential for future growth. If that occurs, the current low P/E could prove to be temporary.
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.’ Although we don’t have analyst forecasts, you might want to assess this data-rich visualization of earnings, revenue and cash flow.
Of course you might be able to find a better stock than Tianjin Tianbao Energy. 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.