The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). To keep it practical, we'll show how The Hong Kong and China Gas Company Limited's (HKG:3) P/E ratio could help you assess the value on offer. Based on the last twelve months, Hong Kong and China Gas's P/E ratio is 30.62. That is equivalent to an earnings yield of about 3.3%.
See our latest analysis for Hong Kong and China Gas
How Do I Calculate Hong Kong and China Gas's Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Hong Kong and China Gas:
P/E of 30.62 = HK$15.22 ÷ HK$0.50 (Based on the trailing twelve months to June 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.
Does Hong Kong and China Gas 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. As you can see below, Hong Kong and China Gas has a higher P/E than the average company (17.6) in the gas utilities industry.
That means that the market expects Hong Kong and China Gas will outperform other companies in its industry. The market is optimistic about the future, but that doesn't guarantee future growth. So investors should delve deeper. I like to check if company insiders have been buying or selling.
How Growth Rates Impact P/E Ratios
Earnings growth rates have a big influence on P/E ratios. When earnings grow, the 'E' increases, over time. 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.
Hong Kong and China Gas's earnings per share fell by 1.5% in the last twelve months. But EPS is up 3.7% over the last 5 years.
Remember: P/E Ratios Don't Consider The Balance Sheet
The 'Price' in P/E reflects the market capitalization of the company. That means it doesn't take debt or cash into account. Theoretically, a business can improve its earnings (and produce a lower P/E in the future) by investing in growth. That means taking on debt (or spending its cash).
While growth expenditure doesn't always pay off, the point is that it is a good option to have; but one that the P/E ratio ignores.