This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We'll look at Hopson Development Holdings Limited's (HKG:754) P/E ratio and reflect on what it tells us about the company's share price. Hopson Development Holdings has a price to earnings ratio of 3.47, based on the last twelve months. That is equivalent to an earnings yield of about 29%.

See our latest analysis for Hopson Development Holdings

How Do I Calculate Hopson Development Holdings's Price To Earnings Ratio?

The formula for price to earnings is:

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

Or for Hopson Development Holdings:

P/E of 3.47 = HK$9 ÷ HK$2.6 (Based on the trailing twelve months to December 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 is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.

How Growth Rates Impact P/E Ratios

Earnings growth rates have a big influence on P/E ratios. That's because companies that grow earnings per share quickly will rapidly increase the 'E' in the equation. 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.

Hopson Development Holdings's earnings per share were pretty steady over the last year. But it has grown its earnings per share by 4.3% per year over the last five years.

Does Hopson Development Holdings Have A Relatively High Or Low P/E For Its Industry?

The P/E ratio indicates whether the market has higher or lower expectations of a company. The image below shows that Hopson Development Holdings has a lower P/E than the average (6.8) P/E for companies in the real estate industry.

This suggests that market participants think Hopson Development 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. 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

One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. 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).