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Despite Its High P/E Ratio, Is Bank of Qingdao Co., Ltd. (HKG:3866) Still Undervalued?

Simply Wall St

The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We'll apply a basic P/E ratio analysis to Bank of Qingdao Co., Ltd.'s (HKG:3866), to help you decide if the stock is worth further research. Based on the last twelve months, Bank of Qingdao's P/E ratio is 15.64. That means that at current prices, buyers pay HK$15.64 for every HK$1 in trailing yearly profits.

View our latest analysis for Bank of Qingdao

How Do I Calculate Bank of Qingdao's Price To Earnings Ratio?

The formula for P/E is:

Price to Earnings Ratio = Share Price (in reporting currency) ÷ Earnings per Share (EPS)

Or for Bank of Qingdao:

P/E of 15.64 = HK$6.12 (Note: this is the share price in the reporting currency, namely, CNY ) ÷ HK$0.39 (Based on the year to September 2019.)

Is A High Price-to-Earnings Ratio Good?

A higher P/E ratio implies that investors pay a higher price for the earning power of the business. All else being equal, it's better to pay a low price -- but as Warren Buffett said, 'It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price.

Does Bank of Qingdao Have A Relatively High Or Low P/E For Its Industry?

We can get an indication of market expectations by looking at the P/E ratio. The image below shows that Bank of Qingdao has a higher P/E than the average (5.8) P/E for companies in the banks industry.

SEHK:3866 Price Estimation Relative to Market, November 24th 2019

Its relatively high P/E ratio indicates that Bank of Qingdao shareholders think it will perform better than other companies in its industry classification. The market is optimistic about the future, but that doesn't guarantee future growth. So further research is always essential. I often monitor director buying and selling.

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.

Bank of Qingdao's earnings per share were pretty steady over the last year. And over the longer term (5 years) earnings per share have decreased 7.7% annually. So it would be surprising to see a high P/E.

Don't Forget: The P/E Does Not Account For Debt or Bank Deposits

The 'Price' in P/E reflects the market capitalization of the company. In other words, it does not consider any debt or cash that the company may have on the balance sheet. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.

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.

Is Debt Impacting Bank of Qingdao's P/E?

Bank of Qingdao has net cash of CN¥14b. This is fairly high at 51% of its market capitalization. That might mean balance sheet strength is important to the business, but should also help push the P/E a bit higher than it would otherwise be.

The Verdict On Bank of Qingdao's P/E Ratio

Bank of Qingdao trades on a P/E ratio of 15.6, which is above its market average of 10.2. The recent drop in earnings per share might keep value investors away, but the relatively strong balance sheet will allow the company time to invest in growth. Clearly, the high P/E indicates shareholders think it will!

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 might want to assess this data-rich visualization of earnings, revenue and cash flow.

Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. 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.

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. Thank you for reading.