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Why Beijing Tong Ren Tang Chinese Medicine Company Limited's (HKG:3613) High P/E Ratio Isn't Necessarily A Bad Thing

Simply Wall St

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 Beijing Tong Ren Tang Chinese Medicine Company Limited's (HKG:3613) P/E ratio to inform your assessment of the investment opportunity. Beijing Tong Ren Tang Chinese Medicine has a price to earnings ratio of 17.2, based on the last twelve months. That means that at current prices, buyers pay HK$17.2 for every HK$1 in trailing yearly profits.

Check out our latest analysis for Beijing Tong Ren Tang Chinese Medicine

How Do I Calculate Beijing Tong Ren Tang Chinese Medicine's Price To Earnings Ratio?

The formula for price to earnings is:

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

Or for Beijing Tong Ren Tang Chinese Medicine:

P/E of 17.2 = HK$12.98 ÷ HK$0.75 (Based on the year to June 2019.)

Is A High P/E Ratio Good?

A higher P/E ratio means that investors are paying a higher price for each HK$1 of company earnings. 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 Does Beijing Tong Ren Tang Chinese Medicine'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, Beijing Tong Ren Tang Chinese Medicine has a higher P/E than the average company (11.5) in the pharmaceuticals industry.

SEHK:3613 Price Estimation Relative to Market, September 4th 2019

Its relatively high P/E ratio indicates that Beijing Tong Ren Tang Chinese Medicine shareholders think it will perform better than other companies in its industry classification. Clearly the market expects growth, but it isn't guaranteed. 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

Earnings growth rates have a big influence on P/E ratios. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. That means unless the share price increases, the P/E will reduce in a few years. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.

It's great to see that Beijing Tong Ren Tang Chinese Medicine grew EPS by 17% in the last year. And earnings per share have improved by 19% annually, over the last five years. This could arguably justify a relatively high P/E ratio.

Remember: P/E Ratios Don't Consider The Balance Sheet

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. In theory, a company can lower its future P/E ratio by using cash or debt to invest in 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.

So What Does Beijing Tong Ren Tang Chinese Medicine's Balance Sheet Tell Us?

With net cash of HK$2.4b, Beijing Tong Ren Tang Chinese Medicine has a very strong balance sheet, which may be important for its business. Having said that, at 22% of its market capitalization the cash hoard would contribute towards a higher P/E ratio.

The Verdict On Beijing Tong Ren Tang Chinese Medicine's P/E Ratio

Beijing Tong Ren Tang Chinese Medicine has a P/E of 17.2. That's higher than the average in its market, which is 10.4. 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.

Investors have an opportunity when market expectations about a stock are wrong. People often underestimate remarkable growth -- so investors can make money when fast growth is not fully appreciated. 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.