Here's How P/E Ratios Can Help Us Understand China Conch Venture Holdings Limited (HKG:586)

Simply Wall St

Tue, May 28, 2019, 10:16 PM

This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We'll show how you can use China Conch Venture Holdings Limited's (HKG:586) P/E ratio to inform your assessment of the investment opportunity. Looking at earnings over the last twelve months, China Conch Venture Holdings has a P/E ratio of 6.75. In other words, at today's prices, investors are paying HK$6.75 for every HK$1 in prior year profit.

See our latest analysis for China Conch Venture Holdings

How Do I Calculate China Conch Venture 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 Conch Venture Holdings:

P/E of 6.75 = CN¥22.23 (Note: this is the share price in the reporting currency, namely, CNY ) ÷ CN¥3.3 (Based on the trailing twelve months to December 2018.)

Is A High Price-to-Earnings Ratio Good?

The higher the P/E ratio, the higher the price tag of a business, relative to its trailing earnings. All else being equal, it's better to pay a low price -- but as Warren Buffett said, 'It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price.'

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. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.

China Conch Venture Holdings's 75% EPS improvement over the last year was like bamboo growth after rain; rapid and impressive. The sweetener is that the annual five year growth rate of 22% is also impressive. With that kind of growth rate we would generally expect a high P/E ratio.

How Does China Conch Venture 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. We can see in the image below that the average P/E (8.7) for companies in the machinery industry is higher than China Conch Venture Holdings's P/E.

SEHK:586 Price Estimation Relative to Market, May 29th 2019

This suggests that market participants think China Conch Venture Holdings will underperform other companies in its industry. Many investors like to buy stocks when the market is pessimistic about their prospects. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.

Don't Forget: The P/E Does Not Account For Debt or Bank Deposits

Don't forget that the P/E ratio considers market capitalization. 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.

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.

So What Does China Conch Venture Holdings's Balance Sheet Tell Us?

China Conch Venture Holdings has net cash of CN¥213m. That should lead to a higher P/E than if it did have debt, because its strong balance sheets gives it more options.

The Verdict On China Conch Venture Holdings's P/E Ratio

China Conch Venture Holdings's P/E is 6.7 which is below average (11.1) in the HK market. It grew its EPS nicely over the last year, and the healthy balance sheet implies there is more potential for growth. The below average P/E ratio suggests that market participants don't believe the strong growth will 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 visual report on analyst forecasts could hold the key to an excellent investment decision.

Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.

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.

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. Thank you for reading.

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