This article is written for those who want to get better at using price to earnings ratios (P/E ratios). To keep it practical, we’ll show how Zhongyuan Bank Co., Ltd.’s (HKG:1216) P/E ratio could help you assess the value on offer. Based on the last twelve months, Zhongyuan Bank’s P/E ratio is 7.49. That is equivalent to an earnings yield of about 13.4%.
Check out our latest analysis for Zhongyuan Bank
How Do I Calculate Zhongyuan Bank’s Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Share Price (in reporting currency) ÷ Earnings per Share (EPS)
Or for Zhongyuan Bank:
P/E of 7.49 = CN¥1.073 ÷ CN¥0.143 (Based on the trailing twelve months to September 2019.)
(Note: the above calculation uses the share price in the reporting currency, namely CNY and the calculation results may not be precise due to rounding.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio means that buyers have to pay a higher price for each CN¥1 the company has earned over the last year. That is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.
Does Zhongyuan Bank Have A Relatively High Or Low P/E For Its Industry?
The P/E ratio essentially measures market expectations of a company. As you can see below, Zhongyuan Bank has a higher P/E than the average company (5.5) in the banks industry.
Its relatively high P/E ratio indicates that Zhongyuan Bank 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.
How Growth Rates Impact P/E Ratios
If earnings fall then in the future the ‘E’ will be lower. Therefore, even if you pay a low multiple of earnings now, that multiple will become higher in the future. Then, a higher P/E might scare off shareholders, pushing the share price down.
Zhongyuan Bank saw earnings per share decrease by 20% last year. And over the longer term (3 years) earnings per share have decreased 11% annually. This growth rate might warrant a low P/E ratio.
Remember: P/E Ratios Don’t Consider The Balance Sheet
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. 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.
How Does Zhongyuan Bank’s Debt Impact Its P/E Ratio?
Net debt totals a substantial 145% of Zhongyuan Bank’s market cap. This level of debt justifies a relatively low P/E, so remain cognizant of the debt, if you’re comparing it to other stocks.
The Bottom Line On Zhongyuan Bank’s P/E Ratio
Zhongyuan Bank’s P/E is 7.5 which is below average (9.2) in the HK market. When you consider that the company has significant debt, and didn’t grow EPS last year, it isn’t surprising that the market has muted expectations.
Investors have an opportunity when market expectations about a stock are wrong. If the reality for a company is not as bad as the P/E ratio indicates, then the share price should increase as the market realizes this. We don’t have analyst forecasts, but you could get a better understanding of its growth by checking out this more detailed historical graph of earnings, revenue and cash flow.
You might be able to find a better buy than Zhongyuan Bank. 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).
If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.