In This Article:
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 Xiwang Special Steel Company Limited's (HKG:1266) P/E ratio could help you assess the value on offer. Looking at earnings over the last twelve months, Xiwang Special Steel has a P/E ratio of 3.03. That corresponds to an earnings yield of approximately 33%.
View our latest analysis for Xiwang Special Steel
How Do I Calculate A 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 Xiwang Special Steel:
P/E of 3.03 = CN¥0.77 (Note: this is the share price in the reporting currency, namely, CNY ) ÷ CN¥0.25 (Based on the trailing twelve months to June 2019.)
Is A High P/E Ratio Good?
A higher P/E ratio implies that investors pay a higher price for the earning power of the business. 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 Does Xiwang Special Steel's P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. If you look at the image below, you can see Xiwang Special Steel has a lower P/E than the average (10.4) in the metals and mining industry classification.
This suggests that market participants think Xiwang Special Steel will underperform other companies in its industry. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.
How Growth Rates Impact P/E Ratios
P/E ratios primarily reflect market expectations around earnings growth rates. Earnings growth means that in the future the 'E' will be higher. And in that case, the P/E ratio itself will drop rather quickly. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.
Xiwang Special Steel saw earnings per share decrease by 53% last year. But EPS is up 4.6% over the last 5 years.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
The 'Price' in P/E reflects the market capitalization of the company. Thus, the metric does not reflect cash or debt held by the company. 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).