This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We'll look at Zhaojin Mining Industry Company Limited's (HKG:1818) P/E ratio and reflect on what it tells us about the company's share price. Based on the last twelve months, Zhaojin Mining Industry's P/E ratio is 58.50. In other words, at today's prices, investors are paying HK$58.50 for every HK$1 in prior year profit.
How Do You Calculate Zhaojin Mining Industry'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 Zhaojin Mining Industry:
P/E of 58.50 = HK$7.47 (Note: this is the share price in the reporting currency, namely, CNY ) ÷ HK$0.13 (Based on the year to June 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 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 Does Zhaojin Mining Industry'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 Zhaojin Mining Industry has a significantly higher P/E than the average (10.6) P/E for companies in the metals and mining industry.
Its relatively high P/E ratio indicates that Zhaojin Mining Industry shareholders think it will perform better than other companies in its industry classification. Clearly the market expects growth, but it isn't guaranteed. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.
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. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
Zhaojin Mining Industry shrunk earnings per share by 25% over the last year. But it has grown its earnings per share by 3.9% per year over the last three years. And it has shrunk its earnings per share by 13% per year over the last five years. This might lead to muted expectations.
Remember: P/E Ratios Don't Consider The Balance Sheet
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. So it won't reflect the advantage of cash, or disadvantage of debt. 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.
Zhaojin Mining Industry's Balance Sheet
Net debt totals 58% of Zhaojin Mining Industry's market cap. This is a reasonably significant level of debt -- all else being equal you'd expect a much lower P/E than if it had net cash.
The Verdict On Zhaojin Mining Industry's P/E Ratio
Zhaojin Mining Industry's P/E is 58.5 which suggests the market is more focussed on the future opportunity rather than the current level of earnings. With relatively high debt, and no earnings per share growth over twelve months, it's safe to say the market believes the company will improve its earnings growth in the future.
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.
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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