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Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll look at Nine Dragons Paper (Holdings) Limited's (HKG:2689) P/E ratio and reflect on what it tells us about the company's share price. Looking at earnings over the last twelve months, Nine Dragons Paper (Holdings) has a P/E ratio of 5.05. In other words, at today's prices, investors are paying HK$5.05 for every HK$1 in prior year profit.
Check out our latest analysis for Nine Dragons Paper (Holdings)
How Do You Calculate Nine Dragons Paper (Holdings)'s P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Share Price (in reporting currency) ÷ Earnings per Share (EPS)
Or for Nine Dragons Paper (Holdings):
P/E of 5.05 = CN¥6.24 (Note: this is the share price in the reporting currency, namely, CNY ) ÷ CN¥1.24 (Based on the trailing twelve months to December 2018.)
Is A High Price-to-Earnings Ratio Good?
The higher the P/E ratio, the higher the price tag of a business, relative to its trailing 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.
How Growth Rates Impact P/E Ratios
P/E ratios primarily reflect market expectations around earnings growth rates. When earnings grow, the 'E' increases, over time. That means even if the current P/E is high, it will reduce over time if the share price stays flat. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
Nine Dragons Paper (Holdings) saw earnings per share decrease by 15% last year. But over the longer term (5 years) earnings per share have increased by 25%.
How Does Nine Dragons Paper (Holdings)'s P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. If you look at the image below, you can see Nine Dragons Paper (Holdings) has a lower P/E than the average (20) in the forestry industry classification.
This suggests that market participants think Nine Dragons Paper (Holdings) will underperform other companies in its industry. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. You should delve deeper. I like to check if company insiders have been buying or 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. 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.