In This Article:
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 First Shanghai Investments Limited's (HKG:227), to help you decide if the stock is worth further research. What is First Shanghai Investments's P/E ratio? Well, based on the last twelve months it is 26.76. That means that at current prices, buyers pay HK$26.76 for every HK$1 in trailing yearly profits.
Check out our latest analysis for First Shanghai Investments
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 First Shanghai Investments:
P/E of 26.76 = HK$0.63 ÷ HK$0.024 (Based on the trailing twelve months to December 2018.)
Is A High Price-to-Earnings 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.
How Growth Rates Impact P/E Ratios
When earnings fall, the 'E' decreases, over time. 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.
First Shanghai Investments's earnings per share fell by 46% in the last twelve months. And EPS is down 5.0% a year, over the last 5 years. This growth rate might warrant a below average P/E ratio.
Does First Shanghai Investments 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. The image below shows that First Shanghai Investments has a higher P/E than the average (16.5) P/E for companies in the capital markets industry.
That means that the market expects First Shanghai Investments will outperform other companies in its industry. Shareholders are clearly optimistic, but the future is always uncertain. So further research is always essential. I often monitor director buying and selling.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. Thus, the metric does not reflect cash or debt held by the company. The exact same company would hypothetically deserve a higher P/E ratio if it had a strong balance sheet, than if it had a weak one with lots of debt, because a cashed up company can spend on growth.