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Should You Be Tempted To Sell Canvest Environmental Protection Group Company Limited (HKG:1381) Because Of Its P/E Ratio?

Simply Wall St

Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll apply a basic P/E ratio analysis to Canvest Environmental Protection Group Company Limited's (HKG:1381), to help you decide if the stock is worth further research. Canvest Environmental Protection Group has a P/E ratio of 9.62, based on the last twelve months. In other words, at today's prices, investors are paying HK$9.62 for every HK$1 in prior year profit.

Check out our latest analysis for Canvest Environmental Protection Group

How Do I Calculate A Price To Earnings Ratio?

The formula for P/E is:

Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)

Or for Canvest Environmental Protection Group:

P/E of 9.62 = HK$3.28 ÷ HK$0.34 (Based on the year to June 2019.)

Is A High Price-to-Earnings Ratio Good?

The higher the P/E ratio, the higher the price tag of a business, relative to its trailing earnings. All else being equal, it's better to pay a low price -- but as Warren Buffett said, 'It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price.

Does Canvest Environmental Protection Group Have A Relatively High Or Low P/E For Its Industry?

We can get an indication of market expectations by looking at the P/E ratio. As you can see below, Canvest Environmental Protection Group has a higher P/E than the average company (7.8) in the renewable energy industry.

SEHK:1381 Price Estimation Relative to Market, December 2nd 2019

Its relatively high P/E ratio indicates that Canvest Environmental Protection Group shareholders think it will perform better than other companies in its industry classification. Shareholders are clearly optimistic, but the future is always uncertain. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.

How Growth Rates Impact P/E Ratios

P/E ratios primarily reflect market expectations around earnings growth rates. When earnings grow, the 'E' increases, over time. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.

It's nice to see that Canvest Environmental Protection Group grew EPS by a stonking 28% in the last year. And its annual EPS growth rate over 5 years is 24%. With that performance, I would expect it to have an above average P/E ratio.

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. Thus, the metric does not reflect cash or debt held by the company. 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.

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.

Is Debt Impacting Canvest Environmental Protection Group's P/E?

Net debt is 42% of Canvest Environmental Protection Group's market cap. While it's worth keeping this in mind, it isn't a worry.

The Verdict On Canvest Environmental Protection Group's P/E Ratio

Canvest Environmental Protection Group trades on a P/E ratio of 9.6, which is fairly close to the HK market average of 10.1. With only modest debt levels, and strong earnings growth, the market seems to doubt that the growth can be maintained. Because analysts are predicting more growth in the future, one might have expected to see a higher P/E ratio. You can take a closer look at the fundamentals, here.

Investors have an opportunity when market expectations about a stock are wrong. 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 Canvest Environmental Protection Group. 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).

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. 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.