This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We’ll look at BYD Electronic (International) Company Limited’s (HKG:285) P/E ratio and reflect on what it tells us about the company’s share price. Based on the last twelve months, BYD Electronic (International)’s P/E ratio is 9.11. That is equivalent to an earnings yield of about 11%.

View our latest analysis for BYD Electronic (International)

How Do You Calculate BYD Electronic (International)’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 BYD Electronic (International):

P/E of 9.11 = CN¥9.69 (Note: this is the share price in the reporting currency, namely, CNY ) ÷ CN¥1.06 (Based on the trailing twelve months to June 2018.)

Is A High P/E Ratio Good?

A higher P/E ratio means that buyers have to pay a higher price for each HK$1 the company has earned over the last year. 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. That means unless the share price increases, the P/E will reduce in a few years. A lower P/E should indicate the stock is cheap relative to others — and that may attract buyers.

BYD Electronic (International) increased earnings per share by an impressive 23% over the last twelve months. And its annual EPS growth rate over 5 years is 31%. This could arguably justify a relatively high P/E ratio.

How Does BYD Electronic (International)’s P/E Ratio Compare To Its Peers?

The P/E ratio essentially measures market expectations of a company. The image below shows that BYD Electronic (International) has a lower P/E than the average (10.2) P/E for companies in the communications industry.

BYD Electronic (International)’s P/E tells us that market participants think it will not fare as well as its peers in the same industry. Many investors like to buy stocks when the market is pessimistic about their prospects. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and selling.

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

Don’t forget that the P/E ratio considers market capitalization. That means it doesn’t take debt or cash into account. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.

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.

How Does BYD Electronic (International)’s Debt Impact Its P/E Ratio?

Since BYD Electronic (International) holds net cash of CN¥3.0b, it can spend on growth, justifying a higher P/E ratio than otherwise.

The Verdict On BYD Electronic (International)’s P/E Ratio

BYD Electronic (International) trades on a P/E ratio of 9.1, which is below the HK market average of 10.9. The net cash position gives plenty of options to the business, and the recent improvement in EPS is good to see. The below average P/E ratio suggests that market participants don’t believe the strong growth will continue.

When the market is wrong about a stock, it gives savvy investors an opportunity. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. So this free visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.

You might be able to find a better buy than BYD Electronic (International). If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).

To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.