Should You Be Tempted To Sell BYD Company Limited (HKG:1211) Because Of Its P/E Ratio?

Will Harmon

Thu, Jan 31, 2019, 5:50 PM

This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). To keep it practical, we’ll show how BYD Company Limited’s (HKG:1211) P/E ratio could help you assess the value on offer. Based on the last twelve months, BYD’s P/E ratio is 43.06. That corresponds to an earnings yield of approximately 2.3%.

See our latest analysis for BYD

How Do I Calculate BYD’s Price To Earnings Ratio?

The formula for price to earnings is:

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

Or for BYD:

P/E of 43.06 = CN¥39.42 (Note: this is the share price in the reporting currency, namely, CNY ) ÷ CN¥0.92 (Based on the trailing twelve months to September 2018.)

Is A High Price-to-Earnings 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. 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

Companies that shrink earnings per share quickly will rapidly decrease the ‘E’ in the equation. That means unless the share price falls, the P/E will increase in a few years. Then, a higher P/E might scare off shareholders, pushing the share price down.

BYD shrunk earnings per share by 37% over the last year. But EPS is up 34% over the last 5 years. And EPS is down 4.5% a year, over the last 3 years. This could justify a low P/E.

How Does BYD’s P/E Ratio Compare To Its Peers?

The P/E ratio indicates whether the market has higher or lower expectations of a company. You can see in the image below that the average P/E (8) for companies in the auto industry is a lot lower than BYD’s P/E.

Its relatively high P/E ratio indicates that BYD shareholders think it will perform better than other companies in its industry classification. Shareholders are clearly optimistic, but the future is always uncertain. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.

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

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. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.