The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We'll look at Hwa Hong Corporation Limited's (SGX:H19) P/E ratio and reflect on what it tells us about the company's share price. What is Hwa Hong's P/E ratio? Well, based on the last twelve months it is 55.22. In other words, at today's prices, investors are paying SGD55.22 for every SGD1 in prior year profit.

See our latest analysis for Hwa Hong

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 Hwa Hong:

P/E of 55.22 = SGD0.29 ÷ SGD0.0053 (Based on the trailing twelve months to June 2019.)

Is A High P/E Ratio Good?

A higher P/E ratio implies that investors pay a higher price for the earning power of the business. 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.

How Does Hwa Hong's P/E Ratio Compare To Its Peers?

We can get an indication of market expectations by looking at the P/E ratio. As you can see below, Hwa Hong has a much higher P/E than the average company (8.2) in the real estate industry.

That means that the market expects Hwa Hong will outperform other companies in its industry. The market is optimistic about the future, but that doesn't guarantee future growth. 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. Therefore, even if you pay a low multiple of earnings now, that multiple will become higher in the future. So while a stock may look cheap based on past earnings, it could be expensive based on future earnings.

Hwa Hong saw earnings per share decrease by 50% last year. And over the longer term (5 years) earnings per share have decreased 23% annually. This growth rate might warrant a below average P/E ratio.

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

Don't forget that the P/E ratio considers market capitalization. Thus, the metric does not reflect cash or debt held by the company. 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).

While growth expenditure doesn't always pay off, the point is that it is a good option to have; but one that the P/E ratio ignores.

Hwa Hong's Balance Sheet

Hwa Hong's net debt equates to 25% of its market capitalization. While it's worth keeping this in mind, it isn't a worry.