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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 China Risun Group Limited's (HKG:1907) P/E ratio could help you assess the value on offer. Based on the last twelve months, China Risun Group's P/E ratio is 4.18. In other words, at today's prices, investors are paying HK$4.18 for every HK$1 in prior year profit.
See our latest analysis for China Risun Group
How Do You Calculate China Risun Group's P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price (in reporting currency) ÷ Earnings per Share (EPS)
Or for China Risun Group:
P/E of 4.18 = CN¥2.6 (Note: this is the share price in the reporting currency, namely, CNY ) ÷ CN¥0.62 (Based on the year to June 2019.)
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 Does China Risun Group's P/E Ratio Compare To Its Peers?
We can get an indication of market expectations by looking at the P/E ratio. If you look at the image below, you can see China Risun Group has a lower P/E than the average (7.1) in the chemicals industry classification.
Its relatively low P/E ratio indicates that China Risun Group 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. You should delve deeper. I like to check if company insiders have been buying or selling.
How Growth Rates Impact P/E Ratios
Generally speaking the rate of earnings growth has a profound impact on a company's P/E multiple. 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.
China Risun Group increased earnings per share by a whopping 46% last year.
Remember: P/E Ratios Don't Consider The Balance Sheet
The 'Price' in P/E reflects the market capitalization of the company. So it won't reflect the advantage of cash, or disadvantage of debt. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.
Such spending might be good or bad, overall, but the key point here is that you need to look at debt to understand the P/E ratio in context.