The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). To keep it practical, we'll show how China Maple Leaf Educational Systems Limited's (HKG:1317) P/E ratio could help you assess the value on offer. China Maple Leaf Educational Systems has a price to earnings ratio of 8.76, based on the last twelve months. That corresponds to an earnings yield of approximately 11.4%.
How Do You Calculate A P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share (in the reporting currency) ÷ Earnings per Share (EPS)
Or for China Maple Leaf Educational Systems:
P/E of 8.76 = CN¥1.871 ÷ CN¥0.214 (Based on the trailing twelve months to February 2020.)
(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 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'.
How Does China Maple Leaf Educational Systems's P/E Ratio Compare To Its Peers?
We can get an indication of market expectations by looking at the P/E ratio. The image below shows that China Maple Leaf Educational Systems has a lower P/E than the average (15.3) P/E for companies in the consumer services industry.
Its relatively low P/E ratio indicates that China Maple Leaf Educational Systems shareholders think it will struggle to do as well as other companies in its industry classification. Many investors like to buy stocks when the market is pessimistic about their prospects. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.
How Growth Rates Impact P/E Ratios
Generally speaking the rate of earnings growth has a profound impact on a company's P/E multiple. Earnings growth means that in the future the 'E' will be higher. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.
China Maple Leaf Educational Systems increased earnings per share by 6.5% last year. And it has bolstered its earnings per share by 62% per year over the last five years.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
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. 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.
Such spending might be good or bad, overall, but the key point here is that you need to look at debt to understand the P/E ratio in context.
Is Debt Impacting China Maple Leaf Educational Systems's P/E?
China Maple Leaf Educational Systems has net cash of CN¥1.8b. This is fairly high at 32% of its market capitalization. That might mean balance sheet strength is important to the business, but should also help push the P/E a bit higher than it would otherwise be.
The Verdict On China Maple Leaf Educational Systems's P/E Ratio
China Maple Leaf Educational Systems trades on a P/E ratio of 8.8, which is fairly close to the HK market average of 9.3. EPS was up modestly better over the last twelve months. And the healthy balance sheet means the company can sustain growth. But the P/E suggests shareholders have some doubts.
Investors should be looking to buy stocks that the market is wrong about. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. So this free report on the analyst consensus forecasts could help you make a master move on this stock.
But note: China Maple Leaf Educational Systems 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).
Love or hate this article? Concerned about the content? Get in touch with us directly. Alternatively, email email@example.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. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned. Thank you for reading.