Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. To keep it practical, we'll show how China Yongda Automobiles Services Holdings Limited's (HKG:3669) P/E ratio could help you assess the value on offer. Looking at earnings over the last twelve months, China Yongda Automobiles Services Holdings has a P/E ratio of 7.39. That is equivalent to an earnings yield of about 13.5%.
How Do I Calculate China Yongda Automobiles Services Holdings'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 China Yongda Automobiles Services Holdings:
P/E of 7.39 = HK$5.08 (Note: this is the share price in the reporting currency, namely, CNY ) ÷ HK$0.69 (Based on the year to June 2019.)
Is A High P/E Ratio Good?
A higher P/E ratio implies that investors pay a higher price for the earning power of the business. 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 China Yongda Automobiles Services Holdings's P/E Ratio Compare To Its Peers?
One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. If you look at the image below, you can see China Yongda Automobiles Services Holdings has a lower P/E than the average (12.6) in the specialty retail industry classification.
China Yongda Automobiles Services Holdings's P/E tells us that market participants think it will not fare as well as its peers in the same industry. Many investors like to buy stocks when the market is pessimistic about their prospects. You should delve deeper. I like to check if company insiders have been buying or selling.
How Growth Rates Impact P/E Ratios
Probably the most important factor in determining what P/E a company trades on is the earnings growth. 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. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
China Yongda Automobiles Services Holdings's earnings per share fell by 21% in the last twelve months. But over the longer term (5 years) earnings per share have increased by 8.8%.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. In other words, it does not consider any debt or cash that the company may have on the balance sheet. 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.
Is Debt Impacting China Yongda Automobiles Services Holdings's P/E?
China Yongda Automobiles Services Holdings's net debt is considerable, at 100% of its market cap. This is a relatively high level of debt, so the stock probably deserves a relatively low P/E ratio. Keep that in mind when comparing it to other companies.
The Verdict On China Yongda Automobiles Services Holdings's P/E Ratio
China Yongda Automobiles Services Holdings trades on a P/E ratio of 7.4, which is below the HK market average of 10.2. Given meaningful debt, and a lack of recent growth, the market looks to be extrapolating this recent performance; reflecting low expectations for the future.
When the market is wrong about a stock, it gives savvy investors an opportunity. If the reality for a company is not as bad as the P/E ratio indicates, then the share price should increase as the market realizes this. 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.
Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.
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.
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.