This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). To keep it practical, we'll show how Haier Electronics Group Co., Ltd.'s (HKG:1169) P/E ratio could help you assess the value on offer. Looking at earnings over the last twelve months, Haier Electronics Group has a P/E ratio of 12.96. In other words, at today's prices, investors are paying HK$12.96 for every HK$1 in prior year profit.

Check out our latest analysis for Haier Electronics Group

How Do You Calculate Haier Electronics Group's P/E Ratio?

The formula for P/E is:

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

Or for Haier Electronics Group:

P/E of 12.96 = CN¥18.705 ÷ CN¥1.443 (Based on the year to December 2019.)

(Note: the above calculation uses the share price in the reporting currency, namely CNY and the calculation results may not be precise due to rounding.)

Is A High Price-to-Earnings Ratio Good?

A higher P/E ratio means that investors are paying a higher price for each CN¥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.

Does Haier Electronics Group 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. The image below shows that Haier Electronics Group has a higher P/E than the average (9.0) P/E for companies in the consumer durables industry.

That means that the market expects Haier Electronics Group will outperform other companies in its industry. Clearly the market expects growth, but it isn't guaranteed. So further research is always essential. I often monitor director buying and selling.

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. When earnings grow, the 'E' increases, over time. 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.

It's great to see that Haier Electronics Group grew EPS by 16% in the last year. And its annual EPS growth rate over 5 years is 9.4%. So one might expect an above average P/E ratio.

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

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. Theoretically, a business can improve its earnings (and produce a lower P/E in the future) by investing in growth. That means taking on debt (or spending its cash).

While growth expenditure doesn't always pay off, the point is that it is a good option to have; but one that the P/E ratio ignores.

How Does Haier Electronics Group's Debt Impact Its P/E Ratio?

With net cash of CN¥18b, Haier Electronics Group has a very strong balance sheet, which may be important for its business. Having said that, at 34% of its market capitalization the cash hoard would contribute towards a higher P/E ratio.

The Verdict On Haier Electronics Group's P/E Ratio

Haier Electronics Group trades on a P/E ratio of 13.0, which is above its market average of 9.3. With cash in the bank the company has plenty of growth options -- and it is already on the right track. Therefore it seems reasonable that the market would have relatively high expectations of the company

Investors have an opportunity when market expectations about a stock are wrong. People often underestimate remarkable growth -- so investors can make money when fast growth is not fully appreciated. So this free report on the analyst consensus forecasts could help you make a master move on this stock.

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.

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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. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned. Thank you for reading.