This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We'll show how you can use Zhengzhou Coal Mining Machinery Group Company Limited's (HKG:564) P/E ratio to inform your assessment of the investment opportunity. Zhengzhou Coal Mining Machinery Group has a P/E ratio of 5.25, based on the last twelve months. That corresponds to an earnings yield of approximately 19.1%.
How Do I Calculate Zhengzhou Coal Mining Machinery Group's Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price (in reporting currency) ÷ Earnings per Share (EPS)
Or for Zhengzhou Coal Mining Machinery Group:
P/E of 5.25 = HK$3.61 (Note: this is the share price in the reporting currency, namely, CNY ) ÷ HK$0.69 (Based on the year to September 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 a good or a bad thing on its own, but a high P/E means that buyers have a higher opinion of the business's prospects, relative to stocks with a lower P/E.
Does Zhengzhou Coal Mining Machinery 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. We can see in the image below that the average P/E (10.2) for companies in the machinery industry is higher than Zhengzhou Coal Mining Machinery Group's P/E.
Its relatively low P/E ratio indicates that Zhengzhou Coal Mining Machinery Group shareholders think it will struggle to do as well as other companies in its industry classification. Since the market seems unimpressed with Zhengzhou Coal Mining Machinery Group, it's quite possible it could surprise on the upside. You should delve deeper. I like to check if company insiders have been buying or selling.
How Growth Rates Impact P/E Ratios
Generally speaking the rate of earnings growth has a profound impact on a company's P/E multiple. Earnings growth means that in the future the 'E' will be higher. 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.
Zhengzhou Coal Mining Machinery Group's earnings made like a rocket, taking off 83% last year. The cherry on top is that the five year growth rate was an impressive 21% per year. With that kind of growth rate we would generally expect a 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. That means it doesn't take debt or cash into account. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.
Such expenditure might be good or bad, in the long term, but the point here is that the balance sheet is not reflected by this ratio.
How Does Zhengzhou Coal Mining Machinery Group's Debt Impact Its P/E Ratio?
Zhengzhou Coal Mining Machinery Group has net cash of CN¥526m. That should lead to a higher P/E than if it did have debt, because its strong balance sheets gives it more options.
The Verdict On Zhengzhou Coal Mining Machinery Group's P/E Ratio
Zhengzhou Coal Mining Machinery Group has a P/E of 5.2. That's below the average in the HK market, which is 10.2. The net cash position gives plenty of options to the business, and the recent improvement in EPS is good to see. The below average P/E ratio suggests that market participants don't believe the strong growth will continue.
Investors should be looking to buy stocks that the market is wrong about. 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 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 be able to find a better stock than Zhengzhou Coal Mining Machinery Group. So you may wish to see this free collection of other companies that have grown earnings strongly.
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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.