In This Article:
This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We'll show how you can use China MeiDong Auto Holdings Limited's (HKG:1268) P/E ratio to inform your assessment of the investment opportunity. China MeiDong Auto Holdings has a price to earnings ratio of 18.50, based on the last twelve months. In other words, at today's prices, investors are paying HK$18.50 for every HK$1 in prior year profit.
See our latest analysis for China MeiDong Auto Holdings
How Do I Calculate A Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share (in the reporting currency) ÷ Earnings per Share (EPS)
Or for China MeiDong Auto Holdings:
P/E of 18.50 = HK$7.08 (Note: this is the share price in the reporting currency, namely, CNY ) ÷ HK$0.38 (Based on the year 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 isn't necessarily good or bad, but a high P/E implies relatively high expectations of what a company can achieve in the future.
How Does China MeiDong Auto Holdings's P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. You can see in the image below that the average P/E (12.6) for companies in the specialty retail industry is lower than China MeiDong Auto Holdings's P/E.
That means that the market expects China MeiDong Auto Holdings will outperform other companies in its industry. The market is optimistic about the future, but that doesn't guarantee future growth. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.
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. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. That means unless the share price increases, the P/E will reduce in a few years. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
It's nice to see that China MeiDong Auto Holdings grew EPS by a stonking 32% in the last year. And its annual EPS growth rate over 5 years is 20%. With that performance, I would expect it to have an above average P/E ratio.
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. That means it doesn't take debt or cash into account. The exact same company would hypothetically deserve a higher P/E ratio if it had a strong balance sheet, than if it had a weak one with lots of debt, because a cashed up company can spend on growth.