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Don't Sell Guangdong Investment Limited (HKG:270) Before You Read This

Simply Wall St
·4 min read

Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll look at Guangdong Investment Limited's (HKG:270) P/E ratio and reflect on what it tells us about the company's share price. Based on the last twelve months, Guangdong Investment's P/E ratio is 21.34. In other words, at today's prices, investors are paying HK$21.34 for every HK$1 in prior year profit.

Check out our latest analysis for Guangdong Investment

How Do You Calculate Guangdong Investment's P/E Ratio?

The formula for P/E is:

Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)

Or for Guangdong Investment:

P/E of 21.34 = HK$15.780 ÷ HK$0.739 (Based on the trailing twelve months to March 2020.)

(Note: the above calculation results may not be precise due to rounding.)

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. 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.

Does Guangdong Investment Have A Relatively High Or Low P/E For Its Industry?

The P/E ratio indicates whether the market has higher or lower expectations of a company. The image below shows that Guangdong Investment has a significantly higher P/E than the average (5.4) P/E for companies in the water utilities industry.

SEHK:270 Price Estimation Relative to Market May 9th 2020
SEHK:270 Price Estimation Relative to Market May 9th 2020

Guangdong Investment's P/E tells us that market participants think the company will perform better than its industry peers, going forward. The market is optimistic about the future, but that doesn't guarantee future growth. 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

P/E ratios primarily reflect market expectations around earnings growth rates. 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. Then, a lower P/E should attract more buyers, pushing the share price up.

Guangdong Investment's earnings per share fell by 3.9% in the last twelve months.

A Limitation: P/E Ratios Ignore Debt and Cash In The Bank

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 Guangdong Investment's P/E?

Since Guangdong Investment holds net cash of HK$3.7b, it can spend on growth, justifying a higher P/E ratio than otherwise.

The Bottom Line On Guangdong Investment's P/E Ratio

Guangdong Investment has a P/E of 21.3. That's higher than the average in its market, which is 9.4. The recent drop in earnings per share might keep value investors away, but the relatively strong balance sheet will allow the company time to invest in growth. Clearly, the high P/E indicates shareholders think it will!

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 visual report on analyst forecasts could hold the key to an excellent investment decision.

But note: Guangdong Investment 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).

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.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.

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. Thank you for reading.