In This Article:
Want to participate in a research study? Help shape the future of investing tools and earn a $60 gift card!
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 Bank of China Limited's (HKG:3988) P/E ratio could help you assess the value on offer. Bank of China has a P/E ratio of 5.15, based on the last twelve months. In other words, at today's prices, investors are paying HK$5.15 for every HK$1 in prior year profit.
See our latest analysis for Bank of China
How Do You Calculate Bank of China's P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share (in the reporting currency) ÷ Earnings per Share (EPS)
Or for Bank of China:
P/E of 5.15 = CN¥3.06 (Note: this is the share price in the reporting currency, namely, CNY ) ÷ CN¥0.59 (Based on the trailing twelve months to September 2018.)
Is A High P/E Ratio Good?
A higher P/E ratio implies that investors pay a higher price for the earning power of the business. 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 Growth Rates Impact P/E Ratios
Probably the most important factor in determining what P/E a company trades on is the earnings growth. That's because companies that grow earnings per share quickly will rapidly increase the 'E' in the equation. That means unless the share price increases, the P/E will reduce in a few years. Then, a lower P/E should attract more buyers, pushing the share price up.
Bank of China's earnings per share grew by -4.5% in the last twelve months. And its annual EPS growth rate over 3 years is 1.1%.
How Does Bank of China'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 Bank of China has a lower P/E than the average (6.1) P/E for companies in the banks industry.
This suggests that market participants think Bank of China will underperform other companies in its industry. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. You should delve deeper. I like to check if company insiders have been buying or 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. In other words, it does not consider any debt or cash that the company may have on the balance sheet. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.