The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We’ll look at China Distance Education Holdings Limited’s (NYSE:DL) P/E ratio and reflect on what it tells us about the company’s share price. Based on the last twelve months, China Distance Education Holdings’s P/E ratio is 21.2. That corresponds to an earnings yield of approximately 4.7%.
How Do You Calculate A P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for China Distance Education Holdings:
P/E of 21.2 = $7.45 ÷ $0.35 (Based on the trailing twelve months to September 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 $1 the company has earned over the last year. 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 unless the share price falls, the P/E will increase in a few years. So while a stock may look cheap based on past earnings, it could be expensive based on future earnings.
China Distance Education Holdings shrunk earnings per share by 22% over the last year. And over the longer term (5 years) earnings per share have decreased 7.0% annually. This could justify a pessimistic P/E.
How Does China Distance Education 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 (23.7) for companies in the consumer services industry is higher than China Distance Education Holdings’s P/E.
This suggests that market participants think China Distance Education Holdings will underperform other companies in its industry. Since the market seems unimpressed with China Distance Education Holdings, it’s quite possible it could surprise on the upside. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
It’s important to note that the P/E ratio considers the market capitalization, not the enterprise value. 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).
Is Debt Impacting China Distance Education Holdings’s P/E?
China Distance Education Holdings has net debt worth just 6.2% of its market capitalization. It would probably trade on a higher P/E ratio if it had a lot of cash, but I doubt it is having a big impact.
The Verdict On China Distance Education Holdings’s P/E Ratio
China Distance Education Holdings trades on a P/E ratio of 21.2, which is above the US market average of 17.1. With some debt but no EPS growth last year, the market has high expectations of future profits.
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.’ We don’t have analyst forecasts, but you could get a better understanding of its growth by checking out this more detailed historical graph of earnings, revenue and cash flow.
But note: China Distance Education Holdings may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
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.