This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We'll show how you can use China Mengniu Dairy Company Limited's (HKG:2319) P/E ratio to inform your assessment of the investment opportunity. Based on the last twelve months, China Mengniu Dairy's P/E ratio is 31.28. That means that at current prices, buyers pay HK$31.28 for every HK$1 in trailing yearly profits.

Check out our latest analysis for China Mengniu Dairy

How Do I Calculate China Mengniu Dairy's Price To Earnings Ratio?

The formula for P/E is:

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

Or for China Mengniu Dairy:

P/E of 31.28 = HK$28.48 (Note: this is the share price in the reporting currency, namely, CNY ) ÷ HK$0.91 (Based on the trailing twelve months 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 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.

Does China Mengniu Dairy Have A Relatively High Or Low P/E For Its Industry?

The P/E ratio indicates whether the market has higher or lower expectations of a company. As you can see below, China Mengniu Dairy has a higher P/E than the average company (15.9) in the food industry.

Its relatively high P/E ratio indicates that China Mengniu Dairy shareholders think it will perform better than other companies in its industry classification. Shareholders are clearly optimistic, but the future is always uncertain. So further research is always essential. I often monitor director buying and 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. Earnings growth means that in the future the 'E' will be higher. And in that case, the P/E ratio itself will drop rather quickly. And as that P/E ratio drops, the company will look cheap, unless its share price increases.

It's nice to see that China Mengniu Dairy grew EPS by a stonking 43% in the last year. And its annual EPS growth rate over 5 years is 12%. I'd therefore be a little surprised if its P/E ratio was not relatively high.

A Limitation: P/E Ratios Ignore Debt and Cash In The Bank

The 'Price' in P/E reflects the market capitalization of the company. That means it doesn't take debt or cash into account. In theory, a company can lower its future P/E ratio by using cash or debt to invest in 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).

How Does China Mengniu Dairy's Debt Impact Its P/E Ratio?

Since China Mengniu Dairy holds net cash of CN¥3.3b, it can spend on growth, justifying a higher P/E ratio than otherwise.

The Bottom Line On China Mengniu Dairy's P/E Ratio

China Mengniu Dairy's P/E is 31.3 which is above average (10.7) in its market. Its net cash position is the cherry on top of its superb EPS growth. So based on this analysis we'd expect China Mengniu Dairy to have a high P/E ratio.

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 visual report on analyst forecasts could hold the key to an excellent investment decision.

But note: China Mengniu Dairy may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).

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.

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. Thank you for reading.