Does China Development Bank International Investment Limited's (HKG:1062) P/E Ratio Signal A Buying Opportunity?

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 China Development Bank International Investment Limited's (HKG:1062) P/E ratio to inform your assessment of the investment opportunity. China Development Bank International Investment has a price to earnings ratio of 3.89, based on the last twelve months. In other words, at today's prices, investors are paying HK$3.89 for every HK$1 in prior year profit.

Want to participate in a short research study? Help shape the future of investing tools and you could win a $250 gift card!

View our latest analysis for China Development Bank International Investment

How Do You Calculate A P/E Ratio?

The formula for P/E is:

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

Or for China Development Bank International Investment:

P/E of 3.89 = HK$0.19 ÷ HK$0.048 (Based on the year to December 2018.)

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 necessarily good or bad, but a high P/E implies relatively high expectations of what a company can achieve in 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. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. 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.

China Development Bank International Investment saw earnings per share decrease by 21% last year. But over the longer term (5 years) earnings per share have increased by 50%.

Does China Development Bank International Investment Have A Relatively High Or Low P/E For Its Industry?

We can get an indication of market expectations by looking at the P/E ratio. We can see in the image below that the average P/E (15.2) for companies in the capital markets industry is higher than China Development Bank International Investment's P/E.

SEHK:1062 Price Estimation Relative to Market, May 21st 2019
SEHK:1062 Price Estimation Relative to Market, May 21st 2019

This suggests that market participants think China Development Bank International Investment will underperform other companies in its industry. Since the market seems unimpressed with China Development Bank International Investment, it's quite possible it could surprise on the upside. 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

It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. Thus, the metric does not reflect cash or debt held by the company. The exact same company would hypothetically deserve a higher P/E ratio if it had a strong balance sheet, than if it had a weak one with lots of debt, because a cashed up company can spend on growth.

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).

So What Does China Development Bank International Investment's Balance Sheet Tell Us?

China Development Bank International Investment's net debt equates to 47% of its market capitalization. While that's enough to warrant consideration, it doesn't really concern us.

The Verdict On China Development Bank International Investment's P/E Ratio

China Development Bank International Investment trades on a P/E ratio of 3.9, which is below the HK market average of 11.1. Since it only carries a modest debt load, it's likely the low expectations implied by the P/E ratio arise from the lack of recent earnings growth.

Investors have an opportunity when market expectations about a stock are wrong. 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.' Although we don't have analyst forecasts, you might want to assess this data-rich visualization of earnings, revenue and cash flow.

But note: China Development Bank International Investment may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).

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.

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. Thank you for reading.