In This Article:
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 Cosmos Machinery Enterprises Limited's (HKG:118) P/E ratio could help you assess the value on offer. Cosmos Machinery Enterprises has a price to earnings ratio of 7.64, based on the last twelve months. That is equivalent to an earnings yield of about 13.1%.
See our latest analysis for Cosmos Machinery Enterprises
How Do I Calculate A Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Cosmos Machinery Enterprises:
P/E of 7.64 = HK$0.28 ÷ HK$0.04 (Based on the trailing twelve months to June 2019.)
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 Does Cosmos Machinery Enterprises's P/E Ratio Compare To Its Peers?
The P/E ratio indicates whether the market has higher or lower expectations of a company. If you look at the image below, you can see Cosmos Machinery Enterprises has a lower P/E than the average (10.0) in the machinery industry classification.
Its relatively low P/E ratio indicates that Cosmos Machinery Enterprises shareholders think it will struggle to do as well as other companies in its industry classification. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and selling.
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. Earnings growth means that in the future the 'E' will be higher. 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.
Cosmos Machinery Enterprises saw earnings per share decrease by 70% last year. And over the longer term (5 years) earnings per share have decreased 24% annually. This could justify a pessimistic P/E.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
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. 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).