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 Resources Pharmaceutical Group Limited's (HKG:3320) P/E ratio could help you assess the value on offer. Looking at earnings over the last twelve months, China Resources Pharmaceutical Group has a P/E ratio of 10.54. In other words, at today's prices, investors are paying HK$10.54 for every HK$1 in prior year profit.
How Do You Calculate China Resources Pharmaceutical Group's P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for China Resources Pharmaceutical Group:
P/E of 10.54 = HK$8.09 ÷ HK$0.77 (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 China Resources Pharmaceutical Group'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 Resources Pharmaceutical Group has a lower P/E than the average (11.5) in the pharmaceuticals industry classification.
This suggests that market participants think China Resources Pharmaceutical Group will underperform other companies in its industry. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.
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. When earnings grow, the 'E' increases, over time. And in that case, the P/E ratio itself will drop rather quickly. And as that P/E ratio drops, the company will look cheap, unless its share price increases.
It's great to see that China Resources Pharmaceutical Group grew EPS by 23% in the last year. And it has bolstered its earnings per share by 2.9% per year over the last five years. So one might expect an above average P/E ratio.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
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.
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 China Resources Pharmaceutical Group's Debt Impact Its P/E Ratio?
China Resources Pharmaceutical Group's net debt equates to 32% of its market capitalization. While it's worth keeping this in mind, it isn't a worry.
The Bottom Line On China Resources Pharmaceutical Group's P/E Ratio
China Resources Pharmaceutical Group has a P/E of 10.5. That's around the same as the average in the HK market, which is 10.5. Given it has reasonable debt levels, and grew earnings strongly last year, the P/E indicates the market has doubts this growth can be sustained.
Investors should be looking to buy stocks that the market is wrong about. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.
Of course you might be able to find a better stock than China Resources Pharmaceutical Group. 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 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.