This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We'll look at China Display Optoelectronics Technology Holdings Limited's (HKG:334) P/E ratio and reflect on what it tells us about the company's share price. Based on the last twelve months, China Display Optoelectronics Technology Holdings's P/E ratio is 9.95. That is equivalent to an earnings yield of about 10.1%.
How Do I Calculate A Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price (in reporting currency) ÷ Earnings per Share (EPS)
Or for China Display Optoelectronics Technology Holdings:
P/E of 9.95 = HK$0.51 (Note: this is the share price in the reporting currency, namely, CNY ) ÷ HK$0.05 (Based on the trailing twelve months 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 necessarily good or bad, but a high P/E implies relatively high expectations of what a company can achieve in the future.
How Does China Display Optoelectronics Technology Holdings'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 China Display Optoelectronics Technology Holdings has a P/E ratio that is roughly in line with the tech industry average (10.0).
That indicates that the market expects China Display Optoelectronics Technology Holdings will perform roughly in line with other companies in its industry. If the company has better than average prospects, then the market might be underestimating it. Checking factors such as director buying and selling. could help you form your own view on if that will happen.
How Growth Rates Impact P/E Ratios
Companies that shrink earnings per share quickly will rapidly decrease the 'E' in the equation. That means unless the share price falls, the P/E will increase in a few years. So while a stock may look cheap based on past earnings, it could be expensive based on future earnings.
China Display Optoelectronics Technology Holdings's earnings made like a rocket, taking off 183% last year. Regrettably, the longer term performance is poor, with EPS down 20% per year over 5 years.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
Don't forget that the P/E ratio considers market capitalization. So it won't reflect the advantage of cash, or disadvantage of debt. 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.
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.
So What Does China Display Optoelectronics Technology Holdings's Balance Sheet Tell Us?
Net debt totals 68% of China Display Optoelectronics Technology Holdings'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 Bottom Line On China Display Optoelectronics Technology Holdings's P/E Ratio
China Display Optoelectronics Technology Holdings's P/E is 9.9 which is about average (10.2) in the HK market. It does have enough debt to add risk, although earnings growth was strong in the last year. The P/E suggests the market isn't confident that growth will be sustained, 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 report on the analyst consensus forecasts could help you make a master move on this stock.
You might be able to find a better buy than China Display Optoelectronics Technology 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 firstname.lastname@example.org. 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.