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Here’s How P/E Ratios Can Help Us Understand Sinopec Shanghai Petrochemical Company Limited (HKG:338)

The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We’ll show how you can use Sinopec Shanghai Petrochemical Company Limited’s (HKG:338) P/E ratio to inform your assessment of the investment opportunity. Based on the last twelve months, Sinopec Shanghai Petrochemical’s P/E ratio is 5.2. That means that at current prices, buyers pay HK$5.2 for every HK$1 in trailing yearly profits.

Check out our latest analysis for Sinopec Shanghai Petrochemical

How Do You Calculate Sinopec Shanghai Petrochemical’s P/E Ratio?

The formula for price to earnings is:

Price to Earnings Ratio = Share Price (in reporting currency) ÷ Earnings per Share (EPS)

Or for Sinopec Shanghai Petrochemical:

P/E of 5.2 = CN¥3.22 (Note: this is the share price in the reporting currency, namely, CNY ) ÷ CN¥0.62 (Based on the trailing twelve months to September 2018.)

Is A High P/E 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 Growth Rates Impact P/E Ratios

Earnings growth rates have a big influence on P/E ratios. When earnings grow, the ‘E’ increases, over time. That means even if the current P/E is high, it will reduce over time if the share price stays flat. A lower P/E should indicate the stock is cheap relative to others — and that may attract buyers.

It’s great to see that Sinopec Shanghai Petrochemical grew EPS by 12% in the last year. And earnings per share have improved by 39% annually, over the last five years. So one might expect an above average P/E ratio.

How Does Sinopec Shanghai Petrochemical’s P/E Ratio Compare To Its Peers?

We can get an indication of market expectations by looking at the P/E ratio. If you look at the image below, you can see Sinopec Shanghai Petrochemical has a lower P/E than the average (7.9) in the chemicals industry classification.

SEHK:338 PE PEG Gauge November 21st 18

This suggests that market participants think Sinopec Shanghai Petrochemical will underperform other companies in its industry. Many investors like to buy stocks when the market is pessimistic about their prospects. 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

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.

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.

Sinopec Shanghai Petrochemical’s Balance Sheet

The extra options and safety that comes with Sinopec Shanghai Petrochemical’s CN¥9.7b net cash position means that it deserves a higher P/E than it would if it had a lot of net debt.

The Bottom Line On Sinopec Shanghai Petrochemical’s P/E Ratio

Sinopec Shanghai Petrochemical trades on a P/E ratio of 5.2, which is below the HK market average of 10.9. Not only should the net cash position reduce risk, but the recent growth has been impressive. The relatively low P/E ratio implies the market is pessimistic.

Investors should be looking to buy stocks that the market is wrong about. 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 Sinopec Shanghai Petrochemical. 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).

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 editorial-team@simplywallst.com.