Here's How P/E Ratios Can Help Us Understand China Energy Engineering Corporation Limited (HKG:3996)

Simply Wall St

Wed, Jul 3, 2019, 6:21 PM

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 China Energy Engineering Corporation Limited's (HKG:3996) P/E ratio could help you assess the value on offer. What is China Energy Engineering's P/E ratio? Well, based on the last twelve months it is 5.5. That means that at current prices, buyers pay HK$5.5 for every HK$1 in trailing yearly profits.

See our latest analysis for China Energy Engineering

How Do You Calculate China Energy Engineering'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 China Energy Engineering:

P/E of 5.5 = CN¥0.84 (Note: this is the share price in the reporting currency, namely, CNY ) ÷ CN¥0.15 (Based on the trailing twelve months to March 2019.)

Is A High P/E Ratio Good?

A higher P/E ratio means that buyers have to pay a higher price for each HK$1 the company has earned over the last year. 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

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. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.

China Energy Engineering's earnings per share fell by 13% in the last twelve months. But over the longer term (5 years) earnings per share have increased by 20%.

Does China Energy Engineering Have A Relatively High Or Low P/E For Its Industry?

The P/E ratio indicates whether the market has higher or lower expectations of a company. The image below shows that China Energy Engineering has a lower P/E than the average (10.1) P/E for companies in the construction industry.

SEHK:3996 Price Estimation Relative to Market, July 4th 2019

This suggests that market participants think China Energy Engineering will underperform other companies in its industry. Many investors like to buy stocks when the market is pessimistic about their prospects. You should delve deeper. I like to check if company insiders have been buying or selling.

Remember: P/E Ratios Don't Consider The Balance Sheet

The 'Price' in P/E reflects the market capitalization of the company. That means it doesn't take debt or cash into account. 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.

China Energy Engineering's Balance Sheet

China Energy Engineering's net debt is considerable, at 157% of its market cap. This is a relatively high level of debt, so the stock probably deserves a relatively low P/E ratio. Keep that in mind when comparing it to other companies.

The Bottom Line On China Energy Engineering's P/E Ratio

China Energy Engineering trades on a P/E ratio of 5.5, which is below the HK market average of 11.1. When you consider that the company has significant debt, and didn't grow EPS last year, it isn't surprising that the market has muted expectations.

Investors should be looking to buy stocks that the market is wrong about. 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 visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.

Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E 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.

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