Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll look at CIMC Enric Holdings Limited's (HKG:3899) P/E ratio and reflect on what it tells us about the company's share price. CIMC Enric Holdings has a P/E ratio of 9.89, based on the last twelve months. In other words, at today's prices, investors are paying HK$9.89 for every HK$1 in prior year profit.

Check out our latest analysis for CIMC Enric Holdings

How Do I Calculate A Price To Earnings Ratio?

The formula for price to earnings is:

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

Or for CIMC Enric Holdings:

P/E of 9.89 = CNY4.35 (Note: this is the share price in the reporting currency, namely, CNY ) ÷ CNY0.44 (Based on the trailing twelve months to June 2019.)

Is A High Price-to-Earnings Ratio Good?

A higher P/E ratio means that buyers have to pay a higher price for each CNY1 the company has earned over the last year. 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 Does CIMC Enric Holdings's P/E Ratio Compare To Its Peers?

The P/E ratio essentially measures market expectations of a company. We can see in the image below that the average P/E (11.3) for companies in the machinery industry is higher than CIMC Enric Holdings's P/E.

CIMC Enric Holdings'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.

How Growth Rates Impact P/E Ratios

Probably the most important factor in determining what P/E a company trades on is the earnings growth. That's because companies that grow earnings per share quickly will rapidly increase the 'E' in the equation. That means unless the share price increases, the P/E will reduce in a few years. Then, a lower P/E should attract more buyers, pushing the share price up.

Notably, CIMC Enric Holdings grew EPS by a whopping 31% in the last year. Unfortunately, earnings per share are down 3.5% a year, over 5 years.

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

One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. Thus, the metric does not reflect cash or debt held by the company. 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).

How Does CIMC Enric Holdings's Debt Impact Its P/E Ratio?

CIMC Enric Holdings has net cash of CN¥1.5b. This is fairly high at 17% of its market capitalization. That might mean balance sheet strength is important to the business, but should also help push the P/E a bit higher than it would otherwise be.

The Verdict On CIMC Enric Holdings's P/E Ratio

CIMC Enric Holdings trades on a P/E ratio of 9.9, which is fairly close to the HK market average of 10.5. The excess cash it carries is the gravy on top its fast EPS growth. So based on this analysis we'd expect CIMC Enric Holdings to have a higher P/E ratio. Because analysts are even expecting further profit growth, we would venture this stock is worth a closer look..

Investors should be looking to buy stocks that the market is wrong about. If the reality for a company is not as bad as the P/E ratio indicates, then the share price should increase as the market realizes this. So this free report on the analyst consensus forecasts could help you make a master move on this stock.

But note: CIMC Enric Holdings may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio 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.