Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll apply a basic P/E ratio analysis to Sunland Group Limited's (ASX:SDG), to help you decide if the stock is worth further research. Sunland Group has a price to earnings ratio of 14.86, based on the last twelve months. In other words, at today's prices, investors are paying A$14.86 for every A$1 in prior year profit.

View our latest analysis for Sunland Group

How Do I Calculate A Price To Earnings Ratio?

The formula for P/E is:

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

Or for Sunland Group:

P/E of 14.86 = A$1.61 ÷ A$0.11 (Based on the trailing twelve months to December 2018.)

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. That is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.

How Growth Rates Impact P/E Ratios

If earnings fall then in the future the 'E' will be lower. Therefore, even if you pay a low multiple of earnings now, that multiple will become higher in the future. So while a stock may look cheap based on past earnings, it could be expensive based on future earnings.

Sunland Group saw earnings per share decrease by 71% last year. But EPS is up 19% over the last 5 years. And EPS is down 14% a year, over the last 3 years. This could justify a low P/E.

Does Sunland Group Have A Relatively High Or Low P/E For Its Industry?

The P/E ratio essentially measures market expectations of a company. As you can see below, Sunland Group has a higher P/E than the average company (10.2) in the real estate industry.

Its relatively high P/E ratio indicates that Sunland Group shareholders think it will perform better than other companies in its industry classification. The market is optimistic about the future, but that doesn't guarantee future growth. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.

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. 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 investing in growth. That means taking on debt (or spending its cash).

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.