The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). To keep it practical, we’ll show how China Oriental Group Company Limited’s (HKG:581) P/E ratio could help you assess the value on offer. China Oriental Group has a price to earnings ratio of 3.43, based on the last twelve months. That corresponds to an earnings yield of approximately 29%.
How Do I Calculate China Oriental Group’s 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 Oriental Group:
P/E of 3.43 = CN¥5.66 (Note: this is the share price in the reporting currency, namely, CNY ) ÷ CN¥1.65 (Based on the trailing twelve months to June 2018.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio implies that investors pay a higher price for the earning power of the business. 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
Probably the most important factor in determining what P/E a company trades on is the earnings growth. Earnings growth means that in the future the ‘E’ will be higher. That means unless the share price increases, the P/E will reduce in a few years. Then, a lower P/E should attract more buyers, pushing the share price up.
It’s nice to see that China Oriental Group grew EPS by a stonking 154% in the last year. And its annual EPS growth rate over 5 years is 76%. So we’d generally expect it to have a relatively high P/E ratio.
How Does China Oriental Group’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 Oriental Group has a lower P/E than the average (8.2) P/E for companies in the metals and mining industry.
China Oriental Group’s P/E tells us that market participants think it will not fare as well as its peers in the same industry. Since the market seems unimpressed with China Oriental Group, it’s quite possible it could surprise on the upside. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.
Don’t Forget: The P/E Does Not Account For Debt or Bank Deposits
The ‘Price’ in P/E reflects the market capitalization of the company. That means it doesn’t take debt or cash into account. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
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).
China Oriental Group’s Balance Sheet
Since China Oriental Group holds net cash of CN¥4.4b, it can spend on growth, justifying a higher P/E ratio than otherwise.
The Bottom Line On China Oriental Group’s P/E Ratio
China Oriental Group trades on a P/E ratio of 3.4, which is below the HK market average of 10.7. The net cash position gives plenty of options to the business, and the recent improvement in EPS is good to see. The below average P/E ratio suggests that market participants don’t believe the strong growth will continue.
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.
But note: China Oriental Group may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at email@example.com.