Why Shenzhou International Group Holdings Limited's (HKG:2313) High P/E Ratio Isn't Necessarily A Bad Thing

Simply Wall St

Mon, Jun 3, 2019, 6:28 PM

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 Shenzhou International Group Holdings Limited's (HKG:2313) P/E ratio could help you assess the value on offer. What is Shenzhou International Group Holdings's P/E ratio? Well, based on the last twelve months it is 27.34. That corresponds to an earnings yield of approximately 3.7%.

Check out our latest analysis for Shenzhou International Group Holdings

How Do I Calculate Shenzhou International Group Holdings's Price To Earnings Ratio?

The formula for price to earnings is:

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

Or for Shenzhou International Group Holdings:

P/E of 27.34 = CN¥82.57 (Note: this is the share price in the reporting currency, namely, CNY ) ÷ CN¥3.02 (Based on the trailing twelve months to December 2018.)

Is A High Price-to-Earnings Ratio Good?

A higher P/E ratio implies that investors pay a higher price for the earning power of the business. 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 Growth Rates Impact P/E Ratios

Probably the most important factor in determining what P/E a company trades on is the earnings growth. When earnings grow, the 'E' increases, over time. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. And as that P/E ratio drops, the company will look cheap, unless its share price increases.

Most would be impressed by Shenzhou International Group Holdings earnings growth of 17% in the last year. And earnings per share have improved by 18% annually, over the last five years. This could arguably justify a relatively high P/E ratio.

How Does Shenzhou International Group Holdings's P/E Ratio Compare To Its Peers?

We can get an indication of market expectations by looking at the P/E ratio. The image below shows that Shenzhou International Group Holdings has a higher P/E than the average (9.5) P/E for companies in the luxury industry.

SEHK:2313 Price Estimation Relative to Market, June 4th 2019

Its relatively high P/E ratio indicates that Shenzhou International Group Holdings shareholders think it will perform better than other companies in its industry classification. Clearly the market expects growth, but it isn't guaranteed. So further research is always essential. I often monitor director buying and selling.

Remember: P/E Ratios Don't Consider The Balance Sheet

One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. In other words, it does not consider any debt or cash that the company may have on the balance sheet. 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.

Spending on growth might be good or bad a few years later, but the point is that the P/E ratio does not account for the option (or lack thereof).

So What Does Shenzhou International Group Holdings's Balance Sheet Tell Us?

Since Shenzhou International Group Holdings holds net cash of CN¥5.7b, it can spend on growth, justifying a higher P/E ratio than otherwise.

The Verdict On Shenzhou International Group Holdings's P/E Ratio

Shenzhou International Group Holdings trades on a P/E ratio of 27.3, which is above the HK market average of 11. Its net cash position supports a higher P/E ratio, as does its solid recent earnings growth. So it is not surprising the market is probably extrapolating recent growth well into the future, reflected in the relatively high P/E ratio.

When the market is wrong about a stock, it gives savvy investors an opportunity. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. So this free visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.

Of course you might be able to find a better stock than Shenzhou International Group Holdings. So you may wish to see this free collection of other companies that have grown earnings strongly.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.

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