Should We Worry About The Hong Kong and China Gas Company Limited's (HKG:3) P/E Ratio?

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This article is written for those who want to get better at using price to earnings ratios (P/E ratios). To keep it practical, we'll show how The Hong Kong and China Gas Company Limited's (HKG:3) P/E ratio could help you assess the value on offer. Hong Kong and China Gas has a P/E ratio of 31.88, based on the last twelve months. In other words, at today's prices, investors are paying HK$31.88 for every HK$1 in prior year profit.

Check out our latest analysis for Hong Kong and China Gas

How Do I Calculate Hong Kong and China Gas's Price To Earnings Ratio?

The formula for price to earnings is:

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

Or for Hong Kong and China Gas:

P/E of 31.88 = HK$17.54 ÷ HK$0.55 (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 isn't necessarily good or bad, but a high P/E implies relatively high expectations of what a company can achieve in the future.

How Growth Rates Impact P/E Ratios

Generally speaking the rate of earnings growth has a profound impact on a company's P/E multiple. 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. And as that P/E ratio drops, the company will look cheap, unless its share price increases.

It's great to see that Hong Kong and China Gas grew EPS by 13% in the last year. And its annual EPS growth rate over 5 years is 6.3%. With that performance, you might expect an above average P/E ratio.

Does Hong Kong and China Gas 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. You can see in the image below that the average P/E (17.3) for companies in the gas utilities industry is lower than Hong Kong and China Gas's P/E.

Its relatively high P/E ratio indicates that Hong Kong and China Gas shareholders think it will perform better than other companies in its industry classification.

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

The 'Price' in P/E reflects the market capitalization of the company. So it won't reflect the advantage of cash, or disadvantage of debt. The exact same company would hypothetically deserve a higher P/E ratio if it had a strong balance sheet, than if it had a weak one with lots of debt, because a cashed up company can spend on growth.

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.

Hong Kong and China Gas's Balance Sheet

Net debt totals 10% of Hong Kong and China Gas's market cap. It would probably deserve a higher P/E ratio if it was net cash, since it would have more options for growth.

The Verdict On Hong Kong and China Gas's P/E Ratio

Hong Kong and China Gas's P/E is 31.9 which is above average (10.9) in the HK market. The company is not overly constrained by its modest debt levels, and its recent EPS growth very solid. Therefore, it's not particularly surprising that it has a above average P/E ratio.

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 report on the analyst consensus forecasts could help you make a master move on this stock.

You might be able to find a better buy than Hong Kong and China Gas. 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).

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.