The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We’ll look at Zhengzhou Coal Mining Machinery Group Company Limited’s (HKG:564) P/E ratio and reflect on what it tells us about the company’s share price. Zhengzhou Coal Mining Machinery Group has a price to earnings ratio of 8.36, based on the last twelve months. In other words, at today’s prices, investors are paying HK$8.36 for every HK$1 in prior year profit.
How Do You Calculate Zhengzhou Coal Mining Machinery Group’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 Zhengzhou Coal Mining Machinery Group:
P/E of 8.36 = CN¥3.15 (Note: this is the share price in the reporting currency, namely, CNY ) ÷ CN¥0.38 (Based on the trailing twelve months to September 2018.)
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 is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.
How Growth Rates Impact P/E Ratios
Probably the most important factor in determining what P/E a company trades on is the earnings growth. 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. A lower P/E should indicate the stock is cheap relative to others — and that may attract buyers.
It’s nice to see that Zhengzhou Coal Mining Machinery Group grew EPS by a stonking 152% in the last year. And its annual EPS growth rate over 3 years is 93%. So we’d generally expect it to have a relatively high P/E ratio. Unfortunately, earnings per share are down 22% a year, over 5 years.
How Does Zhengzhou Coal Mining Machinery Group’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 (9.1) for companies in the machinery industry is higher than Zhengzhou Coal Mining Machinery Group’s P/E.
Zhengzhou Coal Mining Machinery Group’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. You should delve deeper. I like to check if company insiders have been buying or selling.
Remember: P/E Ratios Don’t Consider The Balance Sheet
The ‘Price’ in P/E reflects the market capitalization of the company. 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.
Spending on growth might be good or bad a few years later, but the point is that the P/E ratio does not account for the option (or lack thereof).
Zhengzhou Coal Mining Machinery Group’s Balance Sheet
Zhengzhou Coal Mining Machinery Group’s net debt is 10% of its market cap. It would probably deserve a higher P/E ratio if it was net cash, since it would have more options for growth.
The Verdict On Zhengzhou Coal Mining Machinery Group’s P/E Ratio
Zhengzhou Coal Mining Machinery Group’s P/E is 8.4 which is below average (10.2) in the HK market. The EPS growth last year was strong, and debt levels are quite reasonable. If the company can continue to grow earnings, then the current P/E may be unjustifiably low. Since analysts are predicting growth will continue, one might expect to see a higher P/E so it may be worth looking closer.
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 they key to an excellent investment decision.
You might be able to find a better buy than Zhengzhou Coal Mining Machinery Group. 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 firstname.lastname@example.org.