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This article is written for those who want to get better at using price to earnings ratios (P/E ratios). To keep it practical, we'll show how Dexin China Holdings Company Limited's (HKG:2019) P/E ratio could help you assess the value on offer. Looking at earnings over the last twelve months, Dexin China Holdings has a P/E ratio of 4.15. That corresponds to an earnings yield of approximately 24%.
See our latest analysis for Dexin China Holdings
How Do You Calculate A P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Share Price (in reporting currency) ÷ Earnings per Share (EPS)
Or for Dexin China Holdings:
P/E of 4.15 = CN¥2.96 (Note: this is the share price in the reporting currency, namely, CNY ) ÷ CN¥0.71 (Based on the trailing twelve months to December 2018.)
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 Dexin China Holdings 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. The image below shows that Dexin China Holdings has a lower P/E than the average (5.8) P/E for companies in the real estate industry.
Its relatively low P/E ratio indicates that Dexin China Holdings 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
Earnings growth rates have a big influence on P/E ratios. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
In the last year, Dexin China Holdings grew EPS like Taylor Swift grew her fan base back in 2010; the 91% gain was both fast and well deserved. The cherry on top is that the five year growth rate was an impressive 115% per year. With that kind of growth rate we would generally expect a high P/E ratio.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
The 'Price' in P/E reflects the market capitalization of the company. Thus, the metric does not reflect cash or debt held by the company. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.