This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We'll look at Sinopharm Group Co. Ltd.'s (HKG:1099) P/E ratio and reflect on what it tells us about the company's share price. Sinopharm Group has a price to earnings ratio of 11.63, based on the last twelve months. That corresponds to an earnings yield of approximately 8.6%.
How Do You Calculate Sinopharm 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 Sinopharm Group:
P/E of 11.63 = HK$23.54 (Note: this is the share price in the reporting currency, namely, CNY ) ÷ HK$2.02 (Based on the year to June 2019.)
Is A High P/E Ratio Good?
A higher P/E ratio means that buyers have to pay a higher price for each HK$1 the company has earned over the last year. 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.
Does Sinopharm Group Have A Relatively High Or Low P/E For Its Industry?
The P/E ratio essentially measures market expectations of a company. We can see in the image below that the average P/E (15.8) for companies in the healthcare industry is higher than Sinopharm Group's P/E.
Its relatively low P/E ratio indicates that Sinopharm Group 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
Generally speaking the rate of earnings growth has a profound impact on a company's P/E multiple. Earnings growth means that in the future the 'E' will be higher. That means even if the current P/E is high, it will reduce over time if the share price stays flat. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
Most would be impressed by Sinopharm Group earnings growth of 11% in the last year. And earnings per share have improved by 15% annually, over the last five years. So one might expect an above average P/E ratio.
Remember: P/E Ratios Don't Consider The Balance Sheet
Don't forget that the P/E ratio considers market capitalization. That means it doesn't take debt or cash into account. 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.
Sinopharm Group's Balance Sheet
Sinopharm Group has net debt worth 52% of its market capitalization. This is enough debt that you'd have to make some adjustments before using the P/E ratio to compare it to a company with net cash.
The Verdict On Sinopharm Group's P/E Ratio
Sinopharm Group trades on a P/E ratio of 11.6, which is above its market average of 10.3. While the meaningful level of debt does limit its options, it has achieved solid growth over the last year. But if growth falters, the relatively high P/E ratio may prove to be unjustified.
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 report on the analyst consensus forecasts could help you make a master move on this stock.
Of course you might be able to find a better stock than Sinopharm Group. So you may wish to see this free collection of other companies that have grown earnings strongly.
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.
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