This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We’ll show how you can use Capital Environment Holdings Limited’s (HKG:3989) P/E ratio to inform your assessment of the investment opportunity. Capital Environment Holdings has a price to earnings ratio of 13.29, based on the last twelve months. That corresponds to an earnings yield of approximately 7.5%.

View our latest analysis for Capital Environment 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 Capital Environment Holdings:

P/E of 13.29 = CN¥0.15 (Note: this is the share price in the reporting currency, namely, CNY ) ÷ CN¥0.011 (Based on the year to June 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 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. When earnings grow, the ‘E’ increases, over time. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. Then, a lower P/E should attract more buyers, pushing the share price up.

It’s nice to see that Capital Environment Holdings grew EPS by a stonking 73% in the last year. And it has bolstered its earnings per share by 74% per year over the last five years. With that performance, I would expect it to have an above average P/E ratio.

How Does Capital Environment Holdings’s P/E Ratio Compare To Its Peers?

The P/E ratio essentially measures market expectations of a company. The image below shows that Capital Environment Holdings has a lower P/E than the average (14.8) P/E for companies in the commercial services industry.

This suggests that market participants think Capital Environment Holdings will underperform other companies in its industry. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. You should delve deeper. I like to check if company insiders have been buying or selling.

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

The ‘Price’ in P/E reflects the market capitalization of the company. That means it doesn’t take debt or cash into account. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.