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The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We'll show how you can use Chongqing Iron & Steel Company Limited's (HKG:1053) P/E ratio to inform your assessment of the investment opportunity. Chongqing Iron & Steel has a P/E ratio of 5.29, based on the last twelve months. In other words, at today's prices, investors are paying HK$5.29 for every HK$1 in prior year profit.
See our latest analysis for Chongqing Iron & Steel
How Do You Calculate Chongqing Iron & Steel'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 Chongqing Iron & Steel:
P/E of 5.29 = CN¥0.98 (Note: this is the share price in the reporting currency, namely, CNY ) ÷ CN¥0.18 (Based on the trailing twelve months to March 2019.)
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. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. And in that case, the P/E ratio itself will drop rather quickly. 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 Chongqing Iron & Steel grew EPS by a stonking 32% in the last year.
Does Chongqing Iron & Steel Have A Relatively High Or Low P/E For Its Industry?
One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. We can see in the image below that the average P/E (8.3) for companies in the metals and mining industry is higher than Chongqing Iron & Steel's P/E.
Its relatively low P/E ratio indicates that Chongqing Iron & Steel shareholders think it will struggle to do as well as other companies in its industry classification. Many investors like to buy stocks when the market is pessimistic about their prospects. You 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
It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. Thus, the metric does not reflect cash or debt held by the company. The exact same company would hypothetically deserve a higher P/E ratio if it had a strong balance sheet, than if it had a weak one with lots of debt, because a cashed up company can spend on growth.