To the annoyance of some shareholders, China Telecom (HKG:728) shares are down a considerable 34% in the last month. That drop has capped off a tough year for shareholders, with the share price down 53% in that time.
All else being equal, a share price drop should make a stock more attractive to potential investors. While the market sentiment towards a stock is very changeable, in the long run, the share price will tend to move in the same direction as earnings per share. The implication here is that long term investors have an opportunity when expectations of a company are too low. Perhaps the simplest way to get a read on investors' expectations of a business is to look at its Price to Earnings Ratio (PE Ratio). A high P/E ratio means that investors have a high expectation about future growth, while a low P/E ratio means they have low expectations about future growth.
Does China Telecom Have A Relatively High Or Low P/E For Its Industry?
We can tell from its P/E ratio of 7.02 that sentiment around China Telecom isn't particularly high. We can see in the image below that the average P/E (10.3) for companies in the telecom industry is higher than China Telecom's P/E.
Its relatively low P/E ratio indicates that China Telecom shareholders think it will struggle to do as well as other companies in its industry classification. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and selling.
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. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. 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.
China Telecom saw earnings per share improve by 9.8% last year.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
Don't forget that the P/E ratio considers market capitalization. That means it doesn't take debt or cash into account. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.
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.
How Does China Telecom's Debt Impact Its P/E Ratio?
China Telecom's net debt equates to 34% of its market capitalization. While it's worth keeping this in mind, it isn't a worry.
The Verdict On China Telecom's P/E Ratio
China Telecom trades on a P/E ratio of 7.0, which is below the HK market average of 8.6. The company does have a little debt, and EPS is moving in the right direction. If you believe growth will continue - or even increase - then the low P/E may signify opportunity. Given China Telecom's P/E ratio has declined from 10.6 to 7.0 in the last month, we know for sure that the market is more worried about the business today, than it was back then. For those who prefer invest in growth, this stock apparently offers limited promise, but the deep value investors may find the pessimism around this stock enticing.
When the market is wrong about a stock, it gives savvy investors an opportunity. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.
Of course you might be able to find a better stock than China Telecom. So you may wish to see this free collection of other companies that have grown earnings strongly.
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.
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