Despite Its High P/E Ratio, Is CLP Holdings Limited (HKG:2) Still Undervalued?

This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We’ll look at CLP Holdings Limited’s (HKG:2) P/E ratio and reflect on what it tells us about the company’s share price. CLP Holdings has a P/E ratio of 17.09, based on the last twelve months. That corresponds to an earnings yield of approximately 5.9%.

Check out our latest analysis for CLP Holdings

How Do You Calculate CLP Holdings’s P/E Ratio?

The formula for P/E is:

Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)

Or for CLP Holdings:

P/E of 17.09 = HK$91.65 ÷ HK$5.36 (Based on the year to December 2018.)

Is A High Price-to-Earnings Ratio Good?

A higher P/E ratio means that buyers have to pay a higher price for each HK$1 the company has earned over the last year. 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

If earnings fall then in the future the ‘E’ will be lower. That means unless the share price falls, the P/E will increase in a few years. A higher P/E should indicate the stock is expensive relative to others — and that may encourage shareholders to sell.

CLP Holdings shrunk earnings per share by 4.9% last year. But EPS is up 11% over the last 5 years. And it has shrunk its earnings per share by 2.2% per year over the last three years. This growth rate might warrant a low P/E ratio. So it would be surprising to see a high P/E.

How Does CLP Holdings’s P/E Ratio Compare To Its Peers?

We can get an indication of market expectations by looking at the P/E ratio. The image below shows that CLP Holdings has a higher P/E than the average (15.4) P/E for companies in the electric utilities industry.

SEHK:2 Price Estimation Relative to Market, April 1st 2019
SEHK:2 Price Estimation Relative to Market, April 1st 2019

CLP Holdings’s P/E tells us that market participants think the company will perform better than its industry peers, going forward. Shareholders are clearly optimistic, but the future is always uncertain. So further research is always essential. I often monitor director buying and selling.

Remember: P/E Ratios Don’t Consider The Balance Sheet

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. 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).

Spending on growth might be good or bad a few years later, but the point is that the P/E ratio does not account for the option (or lack thereof).

CLP Holdings’s Balance Sheet

CLP Holdings has net debt worth 18% of its market capitalization. This could bring some additional risk, and reduce the number of investment options for management; worth remembering if you compare its P/E to businesses without debt.

The Verdict On CLP Holdings’s P/E Ratio

CLP Holdings’s P/E is 17.1 which is above average (11.8) in the HK market. With some debt but no EPS growth last year, the market has high expectations of future profits.

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 find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.

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 editorial-team@simplywallst.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.