The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We'll show how you can use China Longyuan Power Group Corporation Limited's (HKG:916) P/E ratio to inform your assessment of the investment opportunity. China Longyuan Power Group has a P/E ratio of 7.63, based on the last twelve months. In other words, at today's prices, investors are paying HK$7.63 for every HK$1 in prior year profit.

Check out our latest analysis for China Longyuan Power Group

How Do I Calculate China Longyuan Power Group's Price To Earnings Ratio?

The formula for P/E is:

Price to Earnings Ratio = Share Price (in reporting currency) ÷ Earnings per Share (EPS)

Or for China Longyuan Power Group:

P/E of 7.63 = HK$3.74 (Note: this is the share price in the reporting currency, namely, CNY ) ÷ HK$0.49 (Based on the trailing twelve months to September 2019.)

Is A High P/E Ratio Good?

A higher P/E ratio means that buyers have to pay a higher price for each HK$1 the company has earned over the last year. 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 Does China Longyuan Power Group's P/E Ratio Compare To Its Peers?

We can get an indication of market expectations by looking at the P/E ratio. You can see in the image below that the average P/E (7.6) for companies in the renewable energy industry is roughly the same as China Longyuan Power Group's P/E.

Its P/E ratio suggests that China Longyuan Power Group shareholders think that in the future it will perform about the same as other companies in its industry classification. If the company has better than average prospects, then the market might be underestimating it. I would further inform my view by checking insider buying and selling., among other things.

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. That means even if the current P/E is high, it will reduce over time if the share price stays flat. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.

China Longyuan Power Group shrunk earnings per share by 9.4% last year.

Remember: P/E Ratios Don't Consider The Balance Sheet

It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. In other words, it does not consider any debt or cash that the company may have on the balance sheet. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.

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).

So What Does China Longyuan Power Group's Balance Sheet Tell Us?

China Longyuan Power Group has net debt worth a very significant 252% of its market capitalization. If you want to compare its P/E ratio to other companies, you must keep in mind that these debt levels would usually warrant a relatively low P/E.

The Bottom Line On China Longyuan Power Group's P/E Ratio

China Longyuan Power Group's P/E is 7.6 which is below average (10.2) in the HK market. Given meaningful debt, and a lack of recent growth, the market looks to be extrapolating this recent performance; reflecting low expectations for the future.

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 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.

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.

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. Thank you for reading.