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This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We'll show how you can use China Overseas Property Holdings Limited's (HKG:2669) P/E ratio to inform your assessment of the investment opportunity. China Overseas Property Holdings has a price to earnings ratio of 32.62, based on the last twelve months. In other words, at today's prices, investors are paying HK$32.62 for every HK$1 in prior year profit.
How Do I Calculate China Overseas Property Holdings's Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for China Overseas Property Holdings:
P/E of 32.62 = HK$3.99 ÷ HK$0.12 (Based on the year to December 2018.)
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 necessarily good or bad, but a high P/E implies relatively high expectations of what a company can achieve in the future.
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. 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.
Notably, China Overseas Property Holdings grew EPS by a whopping 31% in the last year. And it has bolstered its earnings per share by 36% per year over the last five years. So we'd generally expect it to have a relatively high P/E ratio.
How Does China Overseas Property Holdings's P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. You can see in the image below that the average P/E (6.6) for companies in the real estate industry is a lot lower than China Overseas Property Holdings's P/E.
That means that the market expects China Overseas Property Holdings will outperform other companies in its industry. Clearly the market expects growth, but it isn't guaranteed. So investors should delve deeper. I like to check if company insiders have been buying or selling.
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. In theory, a company can lower its future P/E ratio by using cash or debt to invest in 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.
China Overseas Property Holdings's Balance Sheet
With net cash of HK$2.5b, China Overseas Property Holdings has a very strong balance sheet, which may be important for its business. Having said that, at 18% of its market capitalization the cash hoard would contribute towards a higher P/E ratio.
The Bottom Line On China Overseas Property Holdings's P/E Ratio
China Overseas Property Holdings's P/E is 32.6 which is above average (11.1) in the HK market. Its net cash position is the cherry on top of its superb EPS growth. To us, this is the sort of company that we would expect to carry an above average price tag (relative to earnings).
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 visual report on analyst forecasts could hold the key to an excellent investment decision.
You might be able to find a better buy than China Overseas Property Holdings. 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).
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 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. Thank you for reading.