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Why Aluminum Corporation of China Limited's (HKG:2600) High P/E Ratio Isn't Necessarily A Bad Thing

Simply Wall St

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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 Aluminum Corporation of China Limited's (HKG:2600), to help you decide if the stock is worth further research. Aluminum of China has a P/E ratio of 46.31, based on the last twelve months. That means that at current prices, buyers pay HK$46.31 for every HK$1 in trailing yearly profits.

View our latest analysis for Aluminum of China

How Do I Calculate Aluminum of China's Price To Earnings Ratio?

The formula for P/E is:

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

Or for Aluminum of China:

P/E of 46.31 = CN¥2.37 (Note: this is the share price in the reporting currency, namely, CNY ) ÷ CN¥0.051 (Based on the trailing twelve months to March 2019.)

Is A High P/E Ratio Good?

A higher P/E ratio implies that investors pay a higher price for the earning power of the business. 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

P/E ratios primarily reflect market expectations around earnings growth rates. Earnings growth means that in the future the 'E' will be higher. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.

Aluminum of China's earnings per share fell by 36% in the last twelve months. But over the longer term (3 years), earnings per share have increased by 101%.

Does Aluminum of China Have A Relatively High Or Low P/E For Its Industry?

The P/E ratio indicates whether the market has higher or lower expectations of a company. The image below shows that Aluminum of China has a significantly higher P/E than the average (8.3) P/E for companies in the metals and mining industry.

SEHK:2600 Price Estimation Relative to Market, May 14th 2019

Aluminum of China's P/E tells us that market participants think the company will perform better than its industry peers, going forward. The market is optimistic about the future, but that doesn't guarantee future growth. So further research is always essential. I often monitor director buying and selling.

A Limitation: P/E Ratios Ignore Debt and Cash In The Bank

Don't forget that the P/E ratio considers market capitalization. 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.

Spending on growth might be good or bad a few years later, but the point is that the P/E ratio does not account for the option (or lack thereof).

So What Does Aluminum of China's Balance Sheet Tell Us?

Aluminum of China has net debt worth a very significant 133% of its market capitalization. This is a relatively high level of debt, so the stock probably deserves a relatively low P/E ratio. Keep that in mind when comparing it to other companies.

The Verdict On Aluminum of China's P/E Ratio

Aluminum of China trades on a P/E ratio of 46.3, which is multiples above the HK market average of 11.5. With significant debt and no EPS growth last year, shareholders are betting on an improvement in earnings from the company.

Investors have an opportunity when market expectations about a stock are wrong. 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 report on the analyst consensus forecasts could help you make a master move on this stock.

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 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. Thank you for reading.