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 Qudian Inc.’s (NYSE:QD) P/E ratio could help you assess the value on offer. Based on the last twelve months, Qudian’s P/E ratio is 4.63. In other words, at today’s prices, investors are paying $4.63 for every $1 in prior year profit.
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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 Qudian:
P/E of 4.63 = CN¥33.46 (Note: this is the share price in the reporting currency, namely, CNY ) ÷ CN¥7.23 (Based on the year to September 2018.)
Is A High P/E Ratio Good?
A higher P/E ratio means that investors are paying a higher price for each $1 of company earnings. 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 Growth Rates Impact P/E Ratios
Earnings growth rates have a big influence on P/E ratios. That’s because companies that grow earnings per share quickly will rapidly increase the ‘E’ in the equation. That means even if the current P/E is high, it will reduce over time if the share price stays flat. A lower P/E should indicate the stock is cheap relative to others — and that may attract buyers.
Qudian’s earnings per share fell by 71% in the last twelve months. But over the longer term (5 years) earnings per share have increased by 43%.
How Does Qudian’s P/E Ratio Compare To Its Peers?
The P/E ratio indicates whether the market has higher or lower expectations of a company. We can see in the image below that the average P/E (9.5) for companies in the consumer finance industry is higher than Qudian’s P/E.
Its relatively low P/E ratio indicates that Qudian 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.
Don’t Forget: The P/E Does Not Account For Debt or Bank Deposits
It’s important to note that the P/E ratio considers the market capitalization, not the enterprise value. That means it doesn’t take debt or cash into account. 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).
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).
How Does Qudian’s Debt Impact Its P/E Ratio?
Net debt totals 20% of Qudian’s market cap. It would probably deserve a higher P/E ratio if it was net cash, since it would have more options for growth.
The Verdict On Qudian’s P/E Ratio
Qudian’s P/E is 4.6 which is below average (16.7) in the US market. With only modest debt, it’s likely the lack of EPS growth at least partially explains the pessimism implied by the P/E ratio.
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.’ So this free visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.
Of course you might be able to find a better stock than Qudian. So you may wish to see this free collection of other companies that have grown earnings strongly.
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 firstname.lastname@example.org.