This article is written for those who want to get better at using price to earnings ratios (P/E ratios). To keep it practical, we'll show how China Aerospace International Holdings Limited's (HKG:31) P/E ratio could help you assess the value on offer. China Aerospace International Holdings has a P/E ratio of 4.35, based on the last twelve months. That is equivalent to an earnings yield of about 23%.
View our latest analysis for China Aerospace International Holdings
How Do I Calculate A Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for China Aerospace International Holdings:
P/E of 4.35 = HK$0.57 ÷ HK$0.13 (Based on the trailing twelve months 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 Growth Rates Impact P/E Ratios
When earnings fall, the 'E' decreases, over time. That means even if the current P/E is low, it will increase over time if the share price stays flat. A higher P/E should indicate the stock is expensive relative to others -- and that may encourage shareholders to sell.
China Aerospace International Holdings shrunk earnings per share by 17% over the last year. And over the longer term (5 years) earnings per share have decreased 4.3% annually. This could justify a pessimistic P/E.
How Does China Aerospace International 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. If you look at the image below, you can see China Aerospace International Holdings has a lower P/E than the average (12) in the electronic industry classification.
China Aerospace International Holdings's P/E tells us that market participants think it will not fare as well as its peers in the same industry. Many investors like to buy stocks when the market is pessimistic about their prospects. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. 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.
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.