This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). To keep it practical, we'll show how Captii Limited's (SGX:AWV) P/E ratio could help you assess the value on offer. What is Captii's P/E ratio? Well, based on the last twelve months it is 5.6. That is equivalent to an earnings yield of about 18%.

Check out our latest analysis for Captii

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 Captii:

P/E of 5.6 = SGD0.41 ÷ SGD0.073 (Based on the trailing twelve months to December 2018.)

Is A High Price-to-Earnings Ratio Good?

A higher P/E ratio means that investors are paying a higher price for each SGD1 of company 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

When earnings fall, the 'E' decreases, over time. That means unless the share price falls, the P/E will increase in a few years. Then, a higher P/E might scare off shareholders, pushing the share price down.

Captii's 101% EPS improvement over the last year was like bamboo growth after rain; rapid and impressive. The sweetener is that the annual five year growth rate of 18% is also impressive. With that kind of growth rate we would generally expect a high P/E ratio. Unfortunately, earnings per share are down 3.1% a year, over 3 years.

Does Captii 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. The image below shows that Captii has a lower P/E than the average (13.4) P/E for companies in the communications industry.

Captii's P/E tells us that market participants think it will not fare as well as its peers in the same industry. 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

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. 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).

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.

How Does Captii's Debt Impact Its P/E Ratio?

With net cash of S$6.7m, Captii has a very strong balance sheet, which may be important for its business. Having said that, at 49% of its market capitalization the cash hoard would contribute towards a higher P/E ratio.

The Bottom Line On Captii's P/E Ratio

Captii trades on a P/E ratio of 5.6, which is below the SG market average of 13.1. Not only should the net cash position reduce risk, but the recent growth has been impressive. One might conclude that the market is a bit pessimistic, given the low P/E ratio.

Investors have an opportunity when market expectations about a stock are wrong. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. Although we don't have analyst forecasts, you could get a better understanding of its growth by checking out this more detailed historical graph of earnings, revenue and cash flow.

Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.

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 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. Thank you for reading.