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The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We'll apply a basic P/E ratio analysis to Datang International Power Generation Co., Ltd.'s (HKG:991), to help you decide if the stock is worth further research. Based on the last twelve months, Datang International Power Generation's P/E ratio is 25.22. That is equivalent to an earnings yield of about 4.0%.
How Do You Calculate Datang International Power Generation's P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share (in the reporting currency) ÷ Earnings per Share (EPS)
Or for Datang International Power Generation:
P/E of 25.22 = CN¥1.66 (Note: this is the share price in the reporting currency, namely, CNY ) ÷ CN¥0.066 (Based on the trailing twelve months to March 2019.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio implies that investors pay a higher price for the earning power of the business. 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.
Does Datang International Power Generation Have A Relatively High Or Low P/E For Its Industry?
One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. As you can see below, Datang International Power Generation has a higher P/E than the average company (9.5) in the renewable energy industry.
That means that the market expects Datang International Power Generation 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.
How Growth Rates Impact P/E Ratios
If earnings fall then in the future the 'E' will be lower. That means unless the share price falls, the P/E will increase in a few years. A higher P/E should indicate the stock is expensive relative to others -- and that may encourage shareholders to sell.
Datang International Power Generation saw earnings per share decrease by 30% last year. And EPS is down 24% a year, over the last 5 years. This could justify a pessimistic P/E.
Remember: P/E Ratios Don't Consider The Balance Sheet
The 'Price' in P/E reflects the market capitalization of the company. In other words, it does not consider any debt or cash that the company may have on the balance sheet. In theory, a company can lower its future P/E ratio by using cash or debt to invest in 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.
Datang International Power Generation's Balance Sheet
Datang International Power Generation's net debt is considerable, at 274% of its market cap. This level of debt justifies a relatively low P/E, so remain cognizant of the debt, if you're comparing it to other stocks.
The Bottom Line On Datang International Power Generation's P/E Ratio
Datang International Power Generation has a P/E of 25.2. That's higher than the average in its market, which is 10.8. 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 email@example.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.