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 China Overseas Property Holdings Limited’s (HKG:2669) P/E ratio to inform your assessment of the investment opportunity. China Overseas Property Holdings has a price to earnings ratio of 20.7, based on the last twelve months. That means that at current prices, buyers pay HK$20.7 for every HK$1 in trailing yearly profits.
How Do You Calculate A P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for China Overseas Property Holdings:
P/E of 20.7 = HK$2.32 ÷ HK$0.11 (Based on the trailing twelve months to June 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 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
P/E ratios primarily reflect market expectations around earnings growth rates. 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.
Notably, China Overseas Property Holdings grew EPS by a whopping 30% in the last year. And it has bolstered its earnings per share by 31% per year over the last five years. With that performance, I would expect it to have an above average P/E ratio.
How Does China Overseas Property Holdings’s P/E Ratio Compare To Its Peers?
We can get an indication of market expectations by looking at the P/E ratio. As you can see below, China Overseas Property Holdings has a much higher P/E than the average company (5.3) in the real estate industry.
That means that the market expects China Overseas Property Holdings will outperform other companies in its industry. The market is optimistic about the future, but that doesn’t guarantee future growth. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
It’s important to note that the P/E ratio considers the market capitalization, not the enterprise value. Thus, the metric does not reflect cash or debt held by the company. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
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.
China Overseas Property Holdings’s Balance Sheet
Since China Overseas Property Holdings holds net cash of HK$2.3b, it can spend on growth, justifying a higher P/E ratio than otherwise.
The Bottom Line On China Overseas Property Holdings’s P/E Ratio
China Overseas Property Holdings’s P/E is 20.7 which is above average (10.2) in the HK market. With cash in the bank the company has plenty of growth options — and it is already on the right track. So it does not seem strange that the P/E is above average.
When the market is wrong about a stock, it gives savvy investors an opportunity. 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 visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.
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.
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.