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 Far East Orchard Limited's (SGX:O10) P/E ratio could help you assess the value on offer. Far East Orchard has a P/E ratio of 17.86, based on the last twelve months. That corresponds to an earnings yield of approximately 5.6%.

Check out our latest analysis for Far East Orchard

How Do I Calculate A Price To Earnings Ratio?

The formula for price to earnings is:

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

Or for Far East Orchard:

P/E of 17.86 = SGD1.18 ÷ SGD0.066 (Based on the year to March 2019.)

Is A High P/E Ratio Good?

A higher P/E ratio means that investors are paying a higher price for each SGD1 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.

How Does Far East Orchard's P/E Ratio Compare To Its Peers?

One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. As you can see below, Far East Orchard has a higher P/E than the average company (8.7) in the real estate industry.

Far East Orchard's P/E tells us that market participants think the company will perform better than its industry peers, going forward. Shareholders are clearly optimistic, but the future is always uncertain. So further research is always essential. I often monitor director buying and selling.

How Growth Rates Impact P/E Ratios

If earnings fall then in the future the 'E' will be lower. That means unless the share price falls, the P/E will increase in a few years. Then, a higher P/E might scare off shareholders, pushing the share price down.

It's great to see that Far East Orchard grew EPS by 18% in the last year. Unfortunately, earnings per share are down 8.4% a year, over 5 years.

Don't Forget: The P/E Does Not Account For Debt or Bank Deposits

The 'Price' in P/E reflects the market capitalization of the company. In other words, it does not consider any debt or cash that the company may have on the balance sheet. 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).

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 Far East Orchard's Debt Impact Its P/E Ratio?

Far East Orchard has net debt equal to 27% of its market cap. You'd want to be aware of this fact, but it doesn't bother us.