This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We'll show how you can use Ten Pao Group Holdings Limited's (HKG:1979) P/E ratio to inform your assessment of the investment opportunity. Based on the last twelve months, Ten Pao Group Holdings's P/E ratio is 13.9. That means that at current prices, buyers pay HK$13.9 for every HK$1 in trailing yearly profits.

See our latest analysis for Ten Pao Group Holdings

How Do You Calculate A P/E Ratio?

The formula for price to earnings is:

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

Or for Ten Pao Group Holdings:

P/E of 13.9 = HK$0.77 ÷ HK$0.055 (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 HK$1 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 Does Ten Pao Group Holdings's P/E Ratio Compare To Its Peers?

We can get an indication of market expectations by looking at the P/E ratio. As you can see below, Ten Pao Group Holdings has a higher P/E than the average company (10.3) in the electrical industry.

Its relatively high P/E ratio indicates that Ten Pao Group Holdings shareholders think it will perform better than other companies in its industry classification. Clearly the market expects growth, but it isn't guaranteed. So investors should delve deeper. I like to check if company insiders have been buying or selling.

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. So while a stock may look cheap based on past earnings, it could be expensive based on future earnings.

Ten Pao Group Holdings shrunk earnings per share by 65% over the last year. And EPS is down 31% a year, over the last 3 years. This might lead to low expectations.

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. 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.

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.