This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We'll apply a basic P/E ratio analysis to Yangtze Optical Fibre And Cable Joint Stock Limited Company's (HKG:6869), to help you decide if the stock is worth further research. Looking at earnings over the last twelve months, Yangtze Optical Fibre And Cable Limited has a P/E ratio of 8.54. In other words, at today's prices, investors are paying HK$8.54 for every HK$1 in prior year profit.
How Do I Calculate Yangtze Optical Fibre And Cable Limited's Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share (in the reporting currency) ÷ Earnings per Share (EPS)
Or for Yangtze Optical Fibre And Cable Limited:
P/E of 8.54 = CN¥12.74 (Note: this is the share price in the reporting currency, namely, CNY ) ÷ CN¥1.49 (Based on the year 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 isn't a good or a bad thing on its own, but a high P/E means that buyers have a higher opinion of the business's prospects, relative to stocks with a lower P/E.
How Does Yangtze Optical Fibre And Cable Limited's P/E Ratio Compare To Its Peers?
The P/E ratio indicates whether the market has higher or lower expectations of a company. We can see in the image below that the average P/E (13) for companies in the communications industry is higher than Yangtze Optical Fibre And Cable Limited's P/E.
Its relatively low P/E ratio indicates that Yangtze Optical Fibre And Cable Limited shareholders think it will struggle to do as well as other companies in its industry classification. Since the market seems unimpressed with Yangtze Optical Fibre And Cable Limited, 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.
How Growth Rates Impact P/E Ratios
P/E ratios primarily reflect market expectations around earnings growth rates. That's because companies that grow earnings per share quickly will rapidly increase the 'E' in the equation. 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.
Yangtze Optical Fibre And Cable Limited saw earnings per share decrease by 33% last year. But over the longer term (5 years) earnings per share have increased by 11%.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
The 'Price' in P/E reflects the market capitalization of the company. That means it doesn't take debt or cash into account. 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.
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.
Yangtze Optical Fibre And Cable Limited's Balance Sheet
Since Yangtze Optical Fibre And Cable Limited holds net cash of CN¥206m, it can spend on growth, justifying a higher P/E ratio than otherwise.
The Bottom Line On Yangtze Optical Fibre And Cable Limited's P/E Ratio
Yangtze Optical Fibre And Cable Limited trades on a P/E ratio of 8.5, which is below the HK market average of 10.6. The recent drop in earnings per share would almost certainly temper expectations, the healthy balance sheet means the company retains potential for future growth. If that occurs, the current low P/E could prove to be temporary.
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 visual report on analyst forecasts could hold the key to an excellent investment decision.
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.
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.