This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). To keep it practical, we'll show how Shanghai Electric Group Company Limited's (HKG:2727) P/E ratio could help you assess the value on offer. What is Shanghai Electric Group's P/E ratio? Well, based on the last twelve months it is 10.25. That corresponds to an earnings yield of approximately 9.8%.
How Do I Calculate Shanghai Electric Group's Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Share Price (in reporting currency) ÷ Earnings per Share (EPS)
Or for Shanghai Electric Group:
P/E of 10.25 = CNY2.10 (Note: this is the share price in the reporting currency, namely, CNY ) ÷ CNY0.20 (Based on the trailing twelve months to September 2019.)
Is A High P/E Ratio Good?
A higher P/E ratio means that investors are paying a higher price for each CNY1 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.
How Does Shanghai Electric Group's P/E Ratio Compare To Its Peers?
We can get an indication of market expectations by looking at the P/E ratio. As you can see below, Shanghai Electric Group has a higher P/E than the average company (8.6) in the electrical industry.
That means that the market expects Shanghai Electric Group will outperform other companies in its industry. The market is optimistic about the future, but that doesn't guarantee future growth. So further research is always essential. I often monitor director buying and selling.
How Growth Rates Impact P/E Ratios
Earnings growth rates have a big influence on P/E ratios. 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. And as that P/E ratio drops, the company will look cheap, unless its share price increases.
Shanghai Electric Group saw earnings per share improve by -4.2% last year. And its annual EPS growth rate over 5 years is 4.0%.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
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).
Spending on growth might be good or bad a few years later, but the point is that the P/E ratio does not account for the option (or lack thereof).
How Does Shanghai Electric Group's Debt Impact Its P/E Ratio?
With net cash of CN¥7.0b, Shanghai Electric Group has a very strong balance sheet, which may be important for its business. Having said that, at 11% of its market capitalization the cash hoard would contribute towards a higher P/E ratio.
The Bottom Line On Shanghai Electric Group's P/E Ratio
Shanghai Electric Group has a P/E of 10.3. That's around the same as the average in the HK market, which is 9.9. Earnings improved over the last year. And the net cash position gives the company many options. The average P/E suggests the market isn't overly optimistic, though.
When the market is wrong about a stock, it gives savvy investors an opportunity. 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 visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.
You might be able to find a better buy than Shanghai Electric Group. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
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.
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.