In This Article:
The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We'll show how you can use Chengdu Expressway Co., Ltd.'s (HKG:1785) P/E ratio to inform your assessment of the investment opportunity. What is Chengdu Expressway's P/E ratio? Well, based on the last twelve months it is 5.66. In other words, at today's prices, investors are paying HK$5.66 for every HK$1 in prior year profit.
View our latest analysis for Chengdu Expressway
How Do I Calculate A Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Share Price (in reporting currency) ÷ Earnings per Share (EPS)
Or for Chengdu Expressway:
P/E of 5.66 = CN¥1.85 (Note: this is the share price in the reporting currency, namely, CNY ) ÷ CN¥0.33 (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.
How Does Chengdu Expressway's P/E Ratio Compare To Its Peers?
The P/E ratio indicates whether the market has higher or lower expectations of a company. The image below shows that Chengdu Expressway has a lower P/E than the average (8.7) P/E for companies in the infrastructure industry.
This suggests that market participants think Chengdu Expressway will underperform other companies in its industry. Many investors like to buy stocks when the market is pessimistic about their prospects. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.
How Growth Rates Impact P/E Ratios
Generally speaking the rate of earnings growth has a profound impact on a company's P/E multiple. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. And in that case, the P/E ratio itself will drop rather quickly. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
Chengdu Expressway saw earnings per share improve by -6.0% last year. And earnings per share have improved by 9.9% annually, over the last five years.
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. So it won't reflect the advantage of cash, or disadvantage of debt. 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).