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This article is written for those who want to get better at using price to earnings ratios (P/E ratios). To keep it practical, we'll show how Anxian Yuan China Holdings Limited's (HKG:922) P/E ratio could help you assess the value on offer. Looking at earnings over the last twelve months, Anxian Yuan China Holdings has a P/E ratio of 10.82. That means that at current prices, buyers pay HK$10.82 for every HK$1 in trailing yearly profits.

View our latest analysis for Anxian Yuan China Holdings

How Do You Calculate A P/E Ratio?

The formula for P/E is:

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

Or for Anxian Yuan China Holdings:

P/E of 10.82 = HK$0.25 ÷ HK$0.023 (Based on the year to March 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 a good or a bad thing on its own, but a high P/E means that buyers have a higher opinion of the business's prospects, relative to stocks with a lower P/E.

How Growth Rates Impact P/E Ratios

P/E ratios primarily reflect market expectations around earnings growth rates. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. And as that P/E ratio drops, the company will look cheap, unless its share price increases.

Anxian Yuan China Holdings's earnings per share fell by 2.2% in the last twelve months. But over the longer term (5 years) earnings per share have increased by 21%.

How Does Anxian Yuan China Holdings's P/E Ratio Compare To Its Peers?

The P/E ratio indicates whether the market has higher or lower expectations of a company. The image below shows that Anxian Yuan China Holdings has a lower P/E than the average (15.9) P/E for companies in the consumer services industry.

This suggests that market participants think Anxian Yuan China Holdings will underperform other companies in its 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.

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

It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. So it won't reflect the advantage of cash, or disadvantage of debt. In theory, a company can lower its future P/E ratio by using cash or debt to invest in 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.

Is Debt Impacting Anxian Yuan China Holdings's P/E?

Anxian Yuan China Holdings's net debt is 85% of its market cap. This is enough debt that you'd have to make some adjustments before using the P/E ratio to compare it to a company with net cash.

The Verdict On Anxian Yuan China Holdings's P/E Ratio

Anxian Yuan China Holdings trades on a P/E ratio of 10.8, which is fairly close to the HK market average of 11.1. With relatively high debt, and no earnings per share growth over twelve months, the P/E suggests that many have an expectation that company will find some growth.

Investors should be looking to buy stocks that the market is wrong about. 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.' We don't have analyst forecasts, but you could get a better understanding of its growth by checking out this more detailed historical graph of earnings, revenue and cash flow.

You might be able to find a better buy than Anxian Yuan China 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).

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.

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. Thank you for reading.