The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). To keep it practical, we'll show how Datang Environment Industry Group Co., Ltd.'s (HKG:1272) P/E ratio could help you assess the value on offer. Datang Environment Industry Group has a P/E ratio of 6.26, based on the last twelve months. That means that at current prices, buyers pay HK$6.26 for every HK$1 in trailing yearly profits.
Want to participate in a short research study? Help shape the future of investing tools and you could win a $250 gift card!
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 Datang Environment Industry Group:
P/E of 6.26 = CN¥1.62 (Note: this is the share price in the reporting currency, namely, CNY ) ÷ CN¥0.26 (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.
How Growth Rates Impact P/E Ratios
If earnings fall then in the future the 'E' will be lower. That means even if the current P/E is low, it will increase over time if the share price stays flat. A higher P/E should indicate the stock is expensive relative to others -- and that may encourage shareholders to sell.
Datang Environment Industry Group saw earnings per share decrease by 12% last year. And EPS is down 13% a year, over the last 5 years. This could justify a pessimistic P/E.
How Does Datang Environment Industry Group's P/E Ratio Compare To Its Peers?
We can get an indication of market expectations by looking at the P/E ratio. The image below shows that Datang Environment Industry Group has a lower P/E than the average (13.4) P/E for companies in the commercial services industry.
This suggests that market participants think Datang Environment Industry Group will underperform other companies in its industry. 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.
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. 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.
So What Does Datang Environment Industry Group's Balance Sheet Tell Us?
Datang Environment Industry Group's net debt is 67% of its market cap. This is a reasonably significant level of debt -- all else being equal you'd expect a much lower P/E than if it had net cash.
The Verdict On Datang Environment Industry Group's P/E Ratio
Datang Environment Industry Group trades on a P/E ratio of 6.3, which is below the HK market average of 11. Given meaningful debt, and a lack of recent growth, the market looks to be extrapolating this recent performance; reflecting low expectations for the future.
Investors should be looking to buy stocks that the market is wrong about. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. Although we don't have analyst forecasts, shareholders might want to examine this detailed historical graph of earnings, revenue and cash flow.
You might be able to find a better buy than Datang Environment Industry 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).
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.