This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We’ll look at Hebei Construction Group Corporation Limited’s (HKG:1727) P/E ratio and reflect on what it tells us about the company’s share price. Hebei Construction Group has a P/E ratio of 7.11, based on the last twelve months. That means that at current prices, buyers pay HK$7.11 for every HK$1 in trailing yearly profits.
How Do You Calculate Hebei Construction Group’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 Hebei Construction Group:
P/E of 7.11 = CN¥5.05 (Note: this is the share price in the reporting currency, namely, CNY ) ÷ CN¥0.71 (Based on the trailing twelve months to June 2018.)
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 a good or a bad thing on its own, but a high P/E means that buyers have a higher opinion of the business’s prospects, relative to stocks with a lower P/E.
How Growth Rates Impact P/E Ratios
Probably the most important factor in determining what P/E a company trades on is the earnings growth. That’s because companies that grow earnings per share quickly will rapidly increase the ‘E’ in the equation. 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.
Hebei Construction Group shrunk earnings per share by 25% over the last year. But it has grown its earnings per share by 14% per year over the last five years.
How Does Hebei Construction 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. If you look at the image below, you can see Hebei Construction Group has a lower P/E than the average (12.2) in the construction industry classification.
Hebei Construction Group’s P/E tells us that market participants think it will not fare as well as its peers in the same industry. Since the market seems unimpressed with Hebei Construction Group, it’s quite possible it could surprise on the upside. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and selling.
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. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
Such spending might be good or bad, overall, but the key point here is that you need to look at debt to understand the P/E ratio in context.
Hebei Construction Group’s Balance Sheet
Since Hebei Construction Group holds net cash of CN¥679m, it can spend on growth, justifying a higher P/E ratio than otherwise.
The Bottom Line On Hebei Construction Group’s P/E Ratio
Hebei Construction Group’s P/E is 7.1 which is below average (10.8) in the HK market. 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. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. 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.
But note: Hebei Construction Group 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).
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.
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.