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The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We'll look at Beijing Enterprises Environment Group Limited's (HKG:154) P/E ratio and reflect on what it tells us about the company's share price. Beijing Enterprises Environment Group has a P/E ratio of 4.19, based on the last twelve months. That means that at current prices, buyers pay HK$4.19 for every HK$1 in trailing yearly profits.
How Do You Calculate A P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Beijing Enterprises Environment Group:
P/E of 4.19 = HK$0.74 ÷ HK$0.18 (Based on the year to December 2018.)
Is A High Price-to-Earnings Ratio Good?
The higher the P/E ratio, the higher the price tag of a business, relative to its trailing earnings. That is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.
Does Beijing Enterprises Environment Group Have A Relatively High Or Low P/E For Its Industry?
One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. The image below shows that Beijing Enterprises Environment Group has a lower P/E than the average (13.3) P/E for companies in the commercial services industry.
Its relatively low P/E ratio indicates that Beijing Enterprises Environment Group shareholders think it will struggle to do as well as other companies in its industry classification. Since the market seems unimpressed with Beijing Enterprises Environment Group, 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.
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.
Beijing Enterprises Environment Group increased earnings per share by a whopping 39% last year. And it has improved its earnings per share by 55% per year over the last three years. With that performance, I would expect it to have an above average P/E ratio.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
Don't forget that the P/E ratio considers market capitalization. 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.
So What Does Beijing Enterprises Environment Group's Balance Sheet Tell Us?
Net debt totals a substantial 204% of Beijing Enterprises Environment Group's market cap. This level of debt justifies a relatively low P/E, so remain cognizant of the debt, if you're comparing it to other stocks.
The Verdict On Beijing Enterprises Environment Group's P/E Ratio
Beijing Enterprises Environment Group has a P/E of 4.2. That's below the average in the HK market, which is 10.7. The company has a meaningful amount of debt on the balance sheet, but that should not eclipse the solid earnings growth. If the company can continue to grow earnings, then the current P/E may be unjustifiably low.
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.' Although we don't have analyst forecasts, shareholders might want to examine this detailed historical graph of earnings, revenue and cash flow.
But note: Beijing Enterprises Environment Group 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).
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 firstname.lastname@example.org. 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.