This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We'll show how you can use Towngas China Company Limited's (HKG:1083) P/E ratio to inform your assessment of the investment opportunity. Towngas China has a price to earnings ratio of 12.66, based on the last twelve months. That means that at current prices, buyers pay HK$12.66 for every HK$1 in trailing yearly profits.
How Do I Calculate Towngas China's Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Towngas China:
P/E of 12.66 = HK$5.93 ÷ HK$0.47 (Based on the trailing twelve months to June 2019.)
Is A High Price-to-Earnings 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. That is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.
How Does Towngas China's P/E Ratio Compare To Its Peers?
We can get an indication of market expectations by looking at the P/E ratio. The image below shows that Towngas China has a lower P/E than the average (19.0) P/E for companies in the gas utilities industry.
Its relatively low P/E ratio indicates that Towngas China shareholders think it will struggle to do as well as other companies in its industry classification. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and selling.
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. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.
Towngas China shrunk earnings per share by 9.2% last year. But it has grown its earnings per share by 3.3% per year over the last five years.
Remember: P/E Ratios Don't Consider The Balance Sheet
Don't forget that the P/E ratio considers market capitalization. Thus, the metric does not reflect cash or debt held by the company. 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 spending might be good or bad, overall, but the key point here is that you need to look at debt to understand the P/E ratio in context.
How Does Towngas China's Debt Impact Its P/E Ratio?
Towngas China's net debt equates to 49% of its market capitalization. While that's enough to warrant consideration, it doesn't really concern us.
The Bottom Line On Towngas China's P/E Ratio
Towngas China's P/E is 12.7 which is above average (10.3) in its market. With some debt but no EPS growth last year, the market has high expectations of future profits.
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 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 Towngas China. So you may wish to see this free collection of other companies that have grown earnings strongly.
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.