The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We’ll show how you can use CK Hutchison Holdings Limited’s (HKG:1) P/E ratio to inform your assessment of the investment opportunity. Based on the last twelve months, CK Hutchison Holdings’s P/E ratio is 8.21. In other words, at today’s prices, investors are paying HK$8.21 for every HK$1 in prior year profit.

View our latest analysis for CK Hutchison Holdings

How Do You Calculate CK Hutchison Holdings’s P/E Ratio?

The formula for price to earnings is:

Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)

Or for CK Hutchison Holdings:

P/E of 8.21 = HK$79.2 ÷ HK$9.64 (Based on the trailing twelve months to June 2018.)

Is A High P/E 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 even if the current P/E is low, it will increase over time if the share price stays flat. A higher P/E should indicate the stock is expensive relative to others — and that may encourage shareholders to sell.

CK Hutchison Holdings increased earnings per share by 9.4% last year. Unfortunately, earnings per share are down 12% a year, over 5 years.

How Does CK Hutchison Holdings’s P/E Ratio Compare To Its Peers?

We can get an indication of market expectations by looking at the P/E ratio. As you can see below, CK Hutchison Holdings has a higher P/E than the average company (6.9) in the industrials industry.

That means that the market expects CK Hutchison Holdings will outperform other companies in its industry. Clearly the market expects growth, but it isn’t guaranteed. So investors should delve deeper. I like to check if company insiders have been buying or selling.

A Limitation: P/E Ratios Ignore Debt and Cash In The Bank

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. Theoretically, a business can improve its earnings (and produce a lower P/E in the future), by taking on debt (or spending its remaining cash).

Such expenditure might be good or bad, in the long term, but the point here is that the balance sheet is not reflected by this ratio.

Is Debt Impacting CK Hutchison Holdings’s P/E?

CK Hutchison Holdings has net debt worth 65% of its market capitalization. This is a reasonably significant level of debt — all else being equal you’d expect a much lower P/E than if it had net cash.

The Verdict On CK Hutchison Holdings’s P/E Ratio

CK Hutchison Holdings trades on a P/E ratio of 8.2, which is below the HK market average of 10.6. While the recent EPS growth is a positive, the significant amount of debt on the balance sheet may be contributing to pessimistic market expectations.

Investors should be looking to buy stocks that the market is wrong about. 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. So this free report on the analyst consensus forecasts could help you make a master move on this stock.

You might be able to find a better buy than CK Hutchison Holdings. 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 editorial-team@simplywallst.com.