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This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). To keep it practical, we’ll show how China Gas Holdings Limited’s (HKG:384) P/E ratio could help you assess the value on offer. China Gas Holdings has a price to earnings ratio of 19.81, based on the last twelve months. That is equivalent to an earnings yield of about 5.0%.
See our latest analysis for China Gas Holdings
How Do You Calculate China Gas Holdings’s P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for China Gas Holdings:
P/E of 19.81 = HK$24.3 ÷ HK$1.23 (Based on the trailing twelve months to March 2018.)
Is A High Price-to-Earnings 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. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. A lower P/E should indicate the stock is cheap relative to others — and that may attract buyers.
China Gas Holdings increased earnings per share by a whopping 45% last year. And it has bolstered its earnings per share by 20% per year over the last five years. So we’d generally expect it to have a relatively high P/E ratio.
How Does China Gas Holdings’s P/E Ratio Compare To Its Peers?
The P/E ratio indicates whether the market has higher or lower expectations of a company. As you can see below, China Gas Holdings has a higher P/E than the average company (16.1) in the gas utilities industry.
That means that the market expects China Gas Holdings will outperform other companies in its industry. Clearly the market expects growth, but it isn’t guaranteed. So investors 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
Don’t forget that the P/E ratio considers market capitalization. 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.
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.