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 Mobile Limited's (HKG:941) P/E ratio and reflect on what it tells us about the company's share price. China Mobile has a price to earnings ratio of 10.79, based on the last twelve months. That means that at current prices, buyers pay HK$10.79 for every HK$1 in trailing yearly profits.
How Do I Calculate China Mobile's Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share (in the reporting currency) ÷ Earnings per Share (EPS)
Or for China Mobile:
P/E of 10.79 = HK$55.09 (Note: this is the share price in the reporting currency, namely, CNY ) ÷ HK$5.11 (Based on the trailing twelve months to September 2019.)
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 Does China Mobile's P/E Ratio Compare To Its Peers?
The P/E ratio indicates whether the market has higher or lower expectations of a company. If you look at the image below, you can see China Mobile has a lower P/E than the average (15.2) in the wireless telecom industry classification.
Its relatively low P/E ratio indicates that China Mobile shareholders think it will struggle to do as well as other companies in its industry classification. Many investors like to buy stocks when the market is pessimistic about their prospects. You 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. That means unless the share price increases, the P/E will reduce in a few years. Then, a lower P/E should attract more buyers, pushing the share price up.
China Mobile saw earnings per share decrease by 11% last year. And over the longer term (5 years) earnings per share have decreased 1.7% annually. This growth rate might warrant a below average P/E ratio.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. That means it doesn't take debt or cash into account. 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.
How Does China Mobile's Debt Impact Its P/E Ratio?
With net cash of CN¥425b, China Mobile has a very strong balance sheet, which may be important for its business. Having said that, at 38% of its market capitalization the cash hoard would contribute towards a higher P/E ratio.
The Verdict On China Mobile's P/E Ratio
China Mobile's P/E is 10.8 which is about average (10.2) in the HK market. Although the recent drop in earnings per share would keep the market cautious, the net cash position means it's not surprising that expectations put the company roughly in line with the market average P/E.
Investors have an opportunity when market expectations about a stock are wrong. People often underestimate remarkable growth -- so investors can make money when fast growth is not fully appreciated. So this free visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.
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 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.
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