What Does China Water Industry Group Limited's (HKG:1129) P/E Ratio Tell You?

This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We'll show how you can use China Water Industry Group Limited's (HKG:1129) P/E ratio to inform your assessment of the investment opportunity. Based on the last twelve months, China Water Industry Group's P/E ratio is 78.34. That means that at current prices, buyers pay HK$78.34 for every HK$1 in trailing yearly profits.

View our latest analysis for China Water Industry Group

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 Water Industry Group:

P/E of 78.34 = HKD0.46 ÷ HKD0.01 (Based on the year to June 2019.)

Is A High Price-to-Earnings Ratio Good?

A higher P/E ratio implies that investors pay a higher price for the earning power of the business. All else being equal, it's better to pay a low price -- but as Warren Buffett said, 'It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price'.

Does China Water Industry Group 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. You can see in the image below that the average P/E (5.6) for companies in the water utilities industry is a lot lower than China Water Industry Group's P/E.

China Water Industry Group's P/E tells us that market participants think the company will perform better than its industry peers, going forward. 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.

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. Earnings growth means that in the future the 'E' will be higher. And in that case, the P/E ratio itself will drop rather quickly. Then, a lower P/E should attract more buyers, pushing the share price up.

China Water Industry Group's earnings per share fell by 68% in the last twelve months. And EPS is down 40% a year, over the last 5 years. This could justify a pessimistic P/E.

Don't Forget: The P/E Does Not Account For Debt or Bank Deposits

One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. Thus, the metric does not reflect cash or debt held by the company. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.

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 China Water Industry Group's Debt Impact Its P/E Ratio?

China Water Industry Group's net debt equates to 37% of its market capitalization. While it's worth keeping this in mind, it isn't a worry.

The Bottom Line On China Water Industry Group's P/E Ratio

China Water Industry Group's P/E is 78.3 which suggests the market is more focussed on the future opportunity rather than the current level of earnings. With a bit of debt, but a lack of recent growth, it's safe to say the market is expecting improved profit performance from the company, in the next few years.

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. Although we don't have analyst forecasts shareholders might want to examine this detailed historical graph of earnings, revenue and cash flow.

But note: China Water Industry Group 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).

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.