The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We'll show how you can use Dongfeng Motor Group Company Limited's (HKG:489) P/E ratio to inform your assessment of the investment opportunity. Dongfeng Motor Group has a price to earnings ratio of 3.91, based on the last twelve months. In other words, at today's prices, investors are paying HK$3.91 for every HK$1 in prior year profit.

See our latest analysis for Dongfeng Motor Group

How Do I Calculate Dongfeng Motor Group's Price To Earnings 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 Dongfeng Motor Group:

P/E of 3.91 = CNY6.09 (Note: this is the share price in the reporting currency, namely, CNY ) ÷ CNY1.56 (Based on the trailing twelve months to June 2019.)

Is A High Price-to-Earnings Ratio Good?

A higher P/E ratio means that buyers have to pay a higher price for each CNY1 the company has earned over the last year. 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.

Does Dongfeng Motor Group Have A Relatively High Or Low P/E For Its Industry?

One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. We can see in the image below that the average P/E (11.5) for companies in the auto industry is higher than Dongfeng Motor Group's P/E.

Dongfeng Motor Group's P/E tells us that market participants think it will not fare as well as its peers in the same industry. Since the market seems unimpressed with Dongfeng Motor Group, it's quite possible it could surprise on the upside. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and selling.

How Growth Rates Impact P/E Ratios

P/E ratios primarily reflect market expectations around earnings growth rates. Earnings growth means that in the future the 'E' will be higher. And in that case, the P/E ratio itself will drop rather quickly. Then, a lower P/E should attract more buyers, pushing the share price up.

Dongfeng Motor Group shrunk earnings per share by 11% over the last year. But it has grown its earnings per share by 5.5% per year over the last three years.

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

Don't forget that the P/E ratio considers market capitalization. That means it doesn't take debt or cash into account. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.