Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. To keep it practical, we'll show how Zhejiang New Century Hotel Management Co., Ltd.'s (HKG:1158) P/E ratio could help you assess the value on offer. Based on the last twelve months, Zhejiang New Century Hotel Management's P/E ratio is 17.38. That corresponds to an earnings yield of approximately 5.8%.
View our latest analysis for Zhejiang New Century Hotel Management
How Do I Calculate A 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 Zhejiang New Century Hotel Management:
P/E of 17.38 = HK$14.21 (Note: this is the share price in the reporting currency, namely, CNY ) ÷ HK$0.82 (Based on the year to June 2019.)
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 is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.
Does Zhejiang New Century Hotel Management 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. As you can see below, Zhejiang New Century Hotel Management has a higher P/E than the average company (12.8) in the hospitality industry.
Zhejiang New Century Hotel Management's P/E tells us that market participants think the company will perform better than its industry peers, going forward. 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
Earnings growth rates have a big influence on P/E ratios. When earnings grow, the 'E' increases, over time. That means unless the share price increases, the P/E will reduce in a few years. Then, a lower P/E should attract more buyers, pushing the share price up.
Zhejiang New Century Hotel Management's earnings per share fell by 1.8% in the last twelve months. But it has grown its earnings per share by 42% per year over the last five years.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
The 'Price' in P/E reflects the market capitalization of the company. That means it doesn't take debt or cash into account. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.