This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We'll look at China Dongxiang (Group) Co., Ltd.'s (HKG:3818) P/E ratio and reflect on what it tells us about the company's share price. Looking at earnings over the last twelve months, China Dongxiang (Group) has a P/E ratio of 7.38. That is equivalent to an earnings yield of about 14%.
How Do You Calculate A P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share (in the reporting currency) ÷ Earnings per Share (EPS)
Or for China Dongxiang (Group):
P/E of 7.38 = CN¥0.88 (Note: this is the share price in the reporting currency, namely, CNY ) ÷ CN¥0.12 (Based on the year to March 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. 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.
How Does China Dongxiang (Group)'s P/E Ratio Compare To Its Peers?
The P/E ratio indicates whether the market has higher or lower expectations of a company. The image below shows that China Dongxiang (Group) has a lower P/E than the average (9.9) P/E for companies in the luxury industry.
Its relatively low P/E ratio indicates that China Dongxiang (Group) 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. 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. That means unless the share price falls, the P/E will increase in a few years. So while a stock may look cheap based on past earnings, it could be expensive based on future earnings.
China Dongxiang (Group)'s earnings per share fell by 14% in the last twelve months. But it has grown its earnings per share by 25% per year over the last five years. And it has shrunk its earnings per share by 9.8% per year over the last three years. This could justify a low P/E.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
The 'Price' in P/E reflects the market capitalization of the company. Thus, the metric does not reflect cash or debt held by the company. The exact same company would hypothetically deserve a higher P/E ratio if it had a strong balance sheet, than if it had a weak one with lots of debt, because a cashed up company can spend on growth.
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.
How Does China Dongxiang (Group)'s Debt Impact Its P/E Ratio?
China Dongxiang (Group) has net cash of CN¥2.0b. This is fairly high at 38% 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 China Dongxiang (Group)'s P/E Ratio
China Dongxiang (Group) has a P/E of 7.4. That's below the average in the HK market, which is 10.7. Falling earnings per share are likely to be keeping potential buyers away, the relatively strong balance sheet will allow the company time to invest in growth. If it achieves that, then there's real potential that the low P/E could eventually indicate undervaluation.
Investors should be looking to buy stocks that the market is wrong about. 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.' So this free visual report on analyst forecasts could hold the key to an excellent investment decision.
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.
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If you spot an error that warrants correction, please contact the editor at email@example.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. Thank you for reading.