Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll show how you can use China Grand Pharmaceutical and Healthcare Holdings Limited's (HKG:512) P/E ratio to inform your assessment of the investment opportunity. What is China Grand Pharmaceutical and Healthcare Holdings's P/E ratio? Well, based on the last twelve months it is 14.69. That means that at current prices, buyers pay HK$14.69 for every HK$1 in trailing yearly profits.
How Do You Calculate China Grand Pharmaceutical and Healthcare Holdings's P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for China Grand Pharmaceutical and Healthcare Holdings:
P/E of 14.69 = HK$4.61 ÷ HK$0.31 (Based on the year to June 2019.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio means that investors are paying a higher price for each HK$1 of company earnings. 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.
How Does China Grand Pharmaceutical and Healthcare Holdings'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 Grand Pharmaceutical and Healthcare Holdings has a higher P/E than the average (12.1) P/E for companies in the pharmaceuticals industry.
That means that the market expects China Grand Pharmaceutical and Healthcare Holdings will outperform other companies in its industry. The market is optimistic about the future, but that doesn't guarantee future growth. So investors should delve deeper. I like to check if company insiders have been buying or selling.
How Growth Rates Impact P/E Ratios
P/E ratios primarily reflect market expectations around earnings growth rates. Earnings growth means that in the future the 'E' will be higher. And in that case, the P/E ratio itself will drop rather quickly. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
It's great to see that China Grand Pharmaceutical and Healthcare Holdings grew EPS by 25% in the last year. And its annual EPS growth rate over 5 years is 37%. With that performance, you might expect an above average P/E ratio.
Remember: P/E Ratios Don't Consider The Balance Sheet
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.
While growth expenditure doesn't always pay off, the point is that it is a good option to have; but one that the P/E ratio ignores.
Is Debt Impacting China Grand Pharmaceutical and Healthcare Holdings's P/E?
China Grand Pharmaceutical and Healthcare Holdings has net debt worth just 8.7% of its market capitalization. The market might award it a higher P/E ratio if it had net cash, but its unlikely this low level of net borrowing is having a big impact on the P/E multiple.
The Verdict On China Grand Pharmaceutical and Healthcare Holdings's P/E Ratio
China Grand Pharmaceutical and Healthcare Holdings has a P/E of 14.7. That's higher than the average in its market, which is 10.5. While the company does use modest debt, its recent earnings growth is very good. So on this analysis it seems reasonable that its P/E ratio is above average.
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. So this free report on the analyst consensus forecasts could help you make a master move on this stock.
But note: China Grand Pharmaceutical and Healthcare Holdings 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).
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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.