This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We'll look at China Saite Group Company Limited's (HKG:153) P/E ratio and reflect on what it tells us about the company's share price. What is China Saite Group's P/E ratio? Well, based on the last twelve months it is 4.17. In other words, at today's prices, investors are paying HK$4.17 for every HK$1 in prior year profit.
How Do You Calculate A P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Share Price (in reporting currency) ÷ Earnings per Share (EPS)
Or for China Saite Group:
P/E of 4.17 = CN¥0.19 (Note: this is the share price in the reporting currency, namely, CNY ) ÷ CN¥0.046 (Based on the trailing twelve months to June 2019.)
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 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 Does China Saite Group's P/E Ratio Compare To Its Peers?
One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. We can see in the image below that the average P/E (9.3) for companies in the construction industry is higher than China Saite Group's P/E.
China Saite Group's P/E tells us that market participants think it will not fare as well as its peers in the same industry. Since the market seems unimpressed with China Saite Group, it's quite possible it could surprise on the upside. You should delve deeper. I like to check if company insiders have been buying or selling.
How Growth Rates Impact P/E Ratios
If earnings fall then in the future the 'E' will be lower. Therefore, even if you pay a low multiple of earnings now, that multiple will become higher in the future. So while a stock may look cheap based on past earnings, it could be expensive based on future earnings.
China Saite Group shrunk earnings per share by 55% over the last year. And EPS is down 24% a year, over the last 5 years. This could justify a pessimistic P/E.
Remember: P/E Ratios Don't Consider The Balance Sheet
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. 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 investing in growth. That means taking on debt (or spending its cash).
Such spending might be good or bad, overall, but the key point here is that you need to look at debt to understand the P/E ratio in context.
China Saite Group's Balance Sheet
China Saite Group's net debt is 1.8% of its market cap. 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 Saite Group's P/E Ratio
China Saite Group has a P/E of 4.2. That's below the average in the HK market, which is 9.8. With only modest debt, it's likely the lack of EPS growth at least partially explains the pessimism implied by the P/E ratio.
Investors have an opportunity when market expectations about a stock are wrong. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. We don't have analyst forecasts, but you might want to assess this data-rich visualization of earnings, revenue and cash flow.
You might be able to find a better buy than China Saite Group. 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).
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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.