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Despite Its High P/E Ratio, Is Industrial and Commercial Bank of China Limited (HKG:1398) 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 show how you can use Industrial and Commercial Bank of China Limited's (HKG:1398) P/E ratio to inform your assessment of the investment opportunity. Looking at earnings over the last twelve months, Industrial and Commercial Bank of China has a P/E ratio of 5.46. In other words, at today's prices, investors are paying HK$5.46 for every HK$1 in prior year profit.

See our latest analysis for Industrial and Commercial Bank of China

How Do You Calculate Industrial and Commercial Bank of China's P/E Ratio?

The formula for P/E is:

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

Or for Industrial and Commercial Bank of China:

P/E of 5.46 = CN¥4.710 ÷ CN¥0.863 (Based on the year to December 2019.)

(Note: the above calculation uses the share price in the reporting currency, namely CNY and the calculation results may not be precise due to rounding.)

Is A High Price-to-Earnings Ratio Good?

A higher P/E ratio means that buyers have to pay a higher price for each CN¥1 the company has earned over the last year. That isn't necessarily good or bad, but a high P/E implies relatively high expectations of what a company can achieve in the future.

Does Industrial and Commercial Bank of China Have A Relatively High Or Low P/E For Its Industry?

The P/E ratio essentially measures market expectations of a company. You can see in the image below that the average P/E (5.2) for companies in the banks industry is roughly the same as Industrial and Commercial Bank of China's P/E.

SEHK:1398 Price Estimation Relative to Market April 6th 2020

That indicates that the market expects Industrial and Commercial Bank of China will perform roughly in line with other companies in its industry. The company could surprise by performing better than average, in the future. Further research into factors such as insider buying and selling, could help you form your own view on whether that is likely.

How Growth Rates Impact P/E Ratios

Earnings growth rates have a big influence on P/E ratios. When earnings grow, the 'E' increases, over time. That means unless the share price increases, the P/E will reduce in a few years. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.

Industrial and Commercial Bank of China's earnings per share grew by 5.0% in the last twelve months. And earnings per share have improved by 1.9% annually, over the last five years.

A Limitation: P/E Ratios Ignore Debt and Cash In The Bank

Don't forget that the P/E ratio considers market capitalization. Thus, the metric does not reflect cash or debt held by the company. 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 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.

Industrial and Commercial Bank of China's Balance Sheet

With net cash of CN¥845b, Industrial and Commercial Bank of China has a very strong balance sheet, which may be important for its business. Having said that, at 47% of its market capitalization the cash hoard would contribute towards a higher P/E ratio.

The Verdict On Industrial and Commercial Bank of China's P/E Ratio

Industrial and Commercial Bank of China has a P/E of 5.5. That's below the average in the HK market, which is 9.1. EPS was up modestly better over the last twelve months. And the net cash position gives the company many options. So it's strange that the low P/E indicates low expectations.

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. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.

But note: Industrial and Commercial Bank of China 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).

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.