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 Cowell e Holdings Inc.'s (HKG:1415) P/E ratio could help you assess the value on offer. Based on the last twelve months, Cowell e Holdings's P/E ratio is 7.36. That corresponds to an earnings yield of approximately 13.6%.

See our latest analysis for Cowell e Holdings

How Do You Calculate A P/E 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 Cowell e Holdings:

P/E of 7.36 = HK$0.15 (Note: this is the share price in the reporting currency, namely, USD ) ÷ HK$0.02 (Based on the trailing twelve months to June 2019.)

Is A High P/E Ratio Good?

The higher the P/E ratio, the higher the price tag of a business, relative to its trailing 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.

Does Cowell e Holdings 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. We can see in the image below that the average P/E (9.4) for companies in the electronic industry is higher than Cowell e Holdings's P/E.

This suggests that market participants think Cowell e Holdings will underperform other companies in its industry. Since the market seems unimpressed with Cowell e Holdings, it's quite possible it could surprise on the upside. You should delve deeper. I like to check if company insiders have been buying or selling.

How Growth Rates Impact P/E Ratios

Companies that shrink earnings per share quickly will rapidly decrease the 'E' in the equation. 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.

Cowell e Holdings saw earnings per share improve by -7.8% last year. But earnings per share are down 21% per year over the last five years.

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. Thus, the metric does not reflect cash or debt held by the company. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.

Such expenditure might be good or bad, in the long term, but the point here is that the balance sheet is not reflected by this ratio.

Cowell e Holdings's Balance Sheet

With net cash of US$160m, Cowell e Holdings has a very strong balance sheet, which may be important for its business. Having said that, at 126% of its market capitalization the cash hoard would contribute towards a higher P/E ratio.

The Verdict On Cowell e Holdings's P/E Ratio

Cowell e Holdings trades on a P/E ratio of 7.4, which is below the HK market average of 10.2. Recent earnings growth wasn't bad. And the net cash position gives the company many options. So it's strange that the low P/E indicates low expectations.

When the market is wrong about a stock, it gives savvy investors an opportunity. 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 report on the analyst consensus forecasts could help you make a master move on this stock.

You might be able to find a better buy than Cowell e Holdings. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).

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.