Here’s What China ZhengTong Auto Services Holdings Limited’s (HKG:1728) P/E Ratio Is Telling Us

Ray Foley

Wed, Dec 19, 2018, 5:05 PM

This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We’ll look at China ZhengTong Auto Services Holdings Limited’s (HKG:1728) P/E ratio and reflect on what it tells us about the company’s share price. China ZhengTong Auto Services Holdings has a price to earnings ratio of 6.07, based on the last twelve months. In other words, at today’s prices, investors are paying HK$6.07 for every HK$1 in prior year profit.

See our latest analysis for China ZhengTong Auto Services Holdings

How Do I Calculate China ZhengTong Auto Services 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 China ZhengTong Auto Services Holdings:

P/E of 6.07 = CN¥3.61 (Note: this is the share price in the reporting currency, namely, CNY ) ÷ CN¥0.59 (Based on the year to June 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. That isn’t a good or a bad thing on its own, but a high P/E means that buyers have a higher opinion of the business’s prospects, relative to stocks with a lower P/E.

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. 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 ZhengTong Auto Services Holdings grew EPS by a stonking 74% in the last year. And earnings per share have improved by 6.3% annually, over the last five years. I’d therefore be a little surprised if its P/E ratio was not relatively high.

How Does China ZhengTong Auto Services 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 China ZhengTong Auto Services Holdings has a lower P/E than the average (8.8) P/E for companies in the specialty retail industry.

China ZhengTong Auto Services Holdings’s P/E tells us that market participants think it will not fare as well as its peers in the same industry. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. If you consider the stock interesting, further research is recommended. For example, 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.

Such expenditure might be good or bad, in the long term, but the point here is that the balance sheet is not reflected by this ratio.

Is Debt Impacting China ZhengTong Auto Services Holdings’s P/E?

China ZhengTong Auto Services Holdings’s net debt is considerable, at 189% of its market cap. If you want to compare its P/E ratio to other companies, you must keep in mind that these debt levels would usually warrant a relatively low P/E.

The Bottom Line On China ZhengTong Auto Services Holdings’s P/E Ratio

China ZhengTong Auto Services Holdings has a P/E of 6.1. That’s below the average in the HK market, which is 10.5. While the EPS growth last year was strong, the significant debt levels reduce the number of options available to management. The low P/E ratio suggests current market expectations are muted, implying these levels of growth will not continue.

Investors should be looking to buy stocks that the market is wrong about. As value investor Benjamin Graham famously said, ‘In the short run, the market is a voting machine but in the long run, it is a weighing machine.’ 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 China ZhengTong Auto Services Holdings. So you may wish to see this free collection of other companies that have grown earnings strongly.

To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.

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