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 PCCW Limited's (HKG:8) P/E ratio could help you assess the value on offer. Looking at earnings over the last twelve months, PCCW has a P/E ratio of 40.83. That is equivalent to an earnings yield of about 2.4%.
How Do I Calculate PCCW's Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for PCCW:
P/E of 40.83 = HK$4.75 ÷ HK$0.12 (Based on the year to December 2018.)
Is A High Price-to-Earnings Ratio Good?
The higher the P/E ratio, the higher the price tag of a business, relative to its trailing earnings. 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
Companies that shrink earnings per share quickly will rapidly decrease the 'E' in the equation. That means unless the share price falls, the P/E will increase in a few years. A higher P/E should indicate the stock is expensive relative to others -- and that may encourage shareholders to sell.
PCCW maintained roughly steady earnings over the last twelve months. And over the longer term (5 years) earnings per share have decreased 15% annually. So it would be surprising to see a high P/E.
Does PCCW Have A Relatively High Or Low P/E For Its Industry?
One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. You can see in the image below that the average P/E (14.9) for companies in the telecom industry is lower than PCCW's P/E.
Its relatively high P/E ratio indicates that PCCW shareholders think it will perform better than other companies in its industry classification. Shareholders are clearly optimistic, but the future is always uncertain. So further research is always essential. I often monitor director buying and selling.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
Don't forget that the P/E ratio considers market capitalization. In other words, it does not consider any debt or cash that the company may have on the balance sheet. 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.
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.
So What Does PCCW's Balance Sheet Tell Us?
PCCW's net debt is considerable, at 128% of its market cap. This is a relatively high level of debt, so the stock probably deserves a relatively low P/E ratio. Keep that in mind when comparing it to other companies.
The Bottom Line On PCCW's P/E Ratio
PCCW has a P/E of 40.8. That's significantly higher than the average in the HK market, which is 12.1. With meaningful debt and only modest recent earnings growth, the market is either expecting reliable long-term growth, or a near-term improvement.
When the market is wrong about a stock, it gives savvy investors an opportunity. People often underestimate remarkable growth -- so investors can make money when fast growth is not fully appreciated. So this free report on the analyst consensus forecasts could help you make a master move on this stock.
Of course you might be able to find a better stock than PCCW. So you may wish to see this free collection of other companies that have grown earnings strongly.
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 firstname.lastname@example.org. 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.