Want to participate in a short research study? Help shape the future of investing tools and you could win a $250 gift card!

Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. To keep it practical, we'll show how Cedar Woods Properties Limited's (ASX:CWP) P/E ratio could help you assess the value on offer. Cedar Woods Properties has a price to earnings ratio of 6.57, based on the last twelve months. That is equivalent to an earnings yield of about 15%.

Check out our latest analysis for Cedar Woods Properties

How Do I Calculate A Price To Earnings Ratio?

The formula for price to earnings is:

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

Or for Cedar Woods Properties:

P/E of 6.57 = A$5.79 ÷ A$0.88 (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 A$1 of company earnings. 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

Earnings growth rates have a big influence on P/E ratios. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. Then, a lower P/E should attract more buyers, pushing the share price up.

In the last year, Cedar Woods Properties grew EPS like Taylor Swift grew her fan base back in 2010; the 51% gain was both fast and well deserved. Having said that, if we look back three years, EPS growth has averaged a comparatively less impressive 10%.

How Does Cedar Woods Properties'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 Cedar Woods Properties has a lower P/E than the average (11.7) P/E for companies in the real estate industry.

This suggests that market participants think Cedar Woods Properties will underperform other companies in its industry. Many investors like to buy stocks when the market is pessimistic about their prospects. You should delve deeper. I like to check if company insiders have been buying or selling.

A Limitation: P/E Ratios Ignore Debt and Cash In The Bank

The 'Price' in P/E reflects the market capitalization of the company. 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.