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Is Zhongsheng Group Holdings Limited's (HKG:881) High P/E Ratio A Problem For Investors?

Simply Wall St

This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). To keep it practical, we'll show how Zhongsheng Group Holdings Limited's (HKG:881) P/E ratio could help you assess the value on offer. Looking at earnings over the last twelve months, Zhongsheng Group Holdings has a P/E ratio of 11.74. That means that at current prices, buyers pay HK$11.74 for every HK$1 in trailing yearly profits.

See our latest analysis for Zhongsheng Group Holdings

How Do I Calculate Zhongsheng Group Holdings'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 Zhongsheng Group Holdings:

P/E of 11.74 = CN¥18.81 (Note: this is the share price in the reporting currency, namely, CNY ) ÷ CN¥1.6 (Based on the year to December 2018.)

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 Does Zhongsheng Group Holdings's P/E Ratio Compare To Its Peers?

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 Zhongsheng Group Holdings has a P/E ratio that is fairly close for the average for the specialty retail industry, which is 11.2.

SEHK:881 Price Estimation Relative to Market, August 8th 2019

That indicates that the market expects Zhongsheng Group Holdings will perform roughly in line with other companies in its industry. The company could surprise by performing better than average, in the future. Further research into factors such as insider buying and selling, could help you form your own view on whether that is likely.

How Growth Rates Impact P/E Ratios

Probably the most important factor in determining what P/E a company trades on is the earnings growth. That's because companies that grow earnings per share quickly will rapidly increase the 'E' in the equation. That means unless the share price increases, the P/E will reduce in a few years. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.

Zhongsheng Group Holdings saw earnings per share improve by -5.6% last year. And it has bolstered its earnings per share by 25% per year over the last five years.

Don't Forget: The P/E Does Not Account For Debt or Bank Deposits

Don't forget that the P/E ratio considers market capitalization. In other words, it does not consider any debt or cash that the company may have on the balance sheet. Theoretically, a business can improve its earnings (and produce a lower P/E in the future) by investing in growth. That means taking on debt (or spending its cash).

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.

Is Debt Impacting Zhongsheng Group Holdings's P/E?

Zhongsheng Group Holdings's net debt equates to 48% of its market capitalization. While it's worth keeping this in mind, it isn't a worry.

The Verdict On Zhongsheng Group Holdings's P/E Ratio

Zhongsheng Group Holdings has a P/E of 11.7. That's higher than the average in its market, which is 10.1. With modest debt relative to its size, and modest earnings growth, the market is likely expecting sustained long-term growth, if not a near-term improvement.

Investors have an opportunity when market expectations about a stock are wrong. 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 visual report on analyst forecasts could hold the key to an excellent investment decision.

But note: Zhongsheng Group Holdings may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio 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.