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Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll apply a basic P/E ratio analysis to China Mengniu Dairy Company Limited's (HKG:2319), to help you decide if the stock is worth further research. Based on the last twelve months, China Mengniu Dairy's P/E ratio is 32.53. In other words, at today's prices, investors are paying HK$32.53 for every HK$1 in prior year profit.
Check out our latest analysis for China Mengniu Dairy
How Do You Calculate China Mengniu Dairy's P/E 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 32.53 = CN¥25.35 (Note: this is the share price in the reporting currency, namely, CNY ) ÷ CN¥0.78 (Based on the trailing twelve months to December 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
P/E ratios primarily reflect market expectations around earnings growth rates. 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. 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 48% in the last year. And earnings per share have improved by 12% annually, over the last five years. I'd therefore be a little surprised if its P/E ratio was not relatively high.
Does China Mengniu Dairy Have A Relatively High Or Low P/E For Its Industry?
The P/E ratio essentially measures market expectations of a company. The image below shows that China Mengniu Dairy has a higher P/E than the average (15.3) P/E for companies in the food industry.
China Mengniu Dairy's P/E tells us that market participants think the company will perform better than its industry peers, going forward. Clearly the market expects growth, but it isn't guaranteed. So further research is always essential. 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. 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.