Is Huadian Power International Corporation Limited's (HKG:1071) High P/E Ratio A Problem For Investors?

Simply Wall St

Thu, Mar 28, 2019, 6:32 PM

The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We'll look at Huadian Power International Corporation Limited's (HKG:1071) P/E ratio and reflect on what it tells us about the company's share price. Huadian Power International has a P/E ratio of 20.87, based on the last twelve months. That means that at current prices, buyers pay HK$20.87 for every HK$1 in trailing yearly profits.

View our latest analysis for Huadian Power International

How Do You Calculate Huadian Power International's P/E Ratio?

The formula for P/E is:

Price to Earnings Ratio = Price per Share (in the reporting currency) ÷ Earnings per Share (EPS)

Or for Huadian Power International:

P/E of 20.87 = CN¥2.75 (Note: this is the share price in the reporting currency, namely, CNY ) ÷ CN¥0.13 (Based on the year to December 2018.)

Is A High P/E Ratio Good?

A higher P/E ratio means that investors are paying a higher price for each HK$1 of company earnings. All else being equal, it's better to pay a low price -- but as Warren Buffett said, 'It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price.'

How Growth Rates Impact P/E Ratios

Companies that shrink earnings per share quickly will rapidly decrease the 'E' in the equation. That means even if the current P/E is low, it will increase over time if the share price stays flat. So while a stock may look cheap based on past earnings, it could be expensive based on future earnings.

It's nice to see that Huadian Power International grew EPS by a stonking 202% in the last year. In contrast, EPS has decreased by 35%, annually, over 5 years.

How Does Huadian Power International's P/E Ratio Compare To Its Peers?

The P/E ratio essentially measures market expectations of a company. As you can see below, Huadian Power International has a higher P/E than the average company (9.9) in the renewable energy industry.

SEHK:1071 Price Estimation Relative to Market, March 29th 2019

Huadian Power International's P/E tells us that market participants think the company will perform better than its industry peers, going forward. Clearly the market expects growth, but it isn't guaranteed. So further research is always essential. I often monitor director buying and selling.

A Limitation: P/E Ratios Ignore Debt and Cash In The Bank

It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. That means it doesn't take debt or cash into account. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.