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 Vtech Holdings Limited's (HKG:303) P/E ratio to inform your assessment of the investment opportunity. Based on the last twelve months, Vtech Holdings's P/E ratio is 12.38. That means that at current prices, buyers pay HK$12.38 for every HK$1 in trailing yearly profits.

View our latest analysis for Vtech Holdings

How Do You Calculate Vtech Holdings's P/E Ratio?

The formula for price to earnings is:

Price to Earnings Ratio = Share Price (in reporting currency) ÷ Earnings per Share (EPS)

Or for Vtech Holdings:

P/E of 12.38 = HK$9.81 (Note: this is the share price in the reporting currency, namely, USD ) ÷ HK$0.79 (Based on the trailing twelve months to September 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 HK$1 the company has earned over the last year. All else being equal, it's better to pay a low price -- but as Warren Buffett said, 'It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price'.

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

The P/E ratio essentially measures market expectations of a company. As you can see below Vtech Holdings has a P/E ratio that is fairly close for the average for the communications industry, which is 13.1.

Vtech Holdings's P/E tells us that market participants think its prospects are roughly in line with its industry. The company could surprise by performing better than average, in the future. Checking factors such as director buying and selling. could help you form your own view on if that will happen.

How Growth Rates Impact P/E Ratios

Generally speaking the rate of earnings growth has a profound impact on a company's P/E multiple. 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. And as that P/E ratio drops, the company will look cheap, unless its share price increases.

Vtech Holdings increased earnings per share by 3.2% last year. And it has improved its earnings per share by 9.2% per year over the last three years. In contrast, EPS has decreased by 1.2%, annually, over 5 years.

Don't Forget: The P/E Does Not Account For Debt or Bank Deposits

The 'Price' in P/E reflects the market capitalization of the company. 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.

So What Does Vtech Holdings's Balance Sheet Tell Us?

The extra options and safety that comes with Vtech Holdings's US$103m net cash position means that it deserves a higher P/E than it would if it had a lot of net debt.

The Bottom Line On Vtech Holdings's P/E Ratio

Vtech Holdings trades on a P/E ratio of 12.4, which is above its market average of 10.7. Recent earnings growth wasn't bad. And the healthy balance sheet means the company can sustain growth while the P/E suggests shareholders think it will.

When the market is wrong about a stock, it gives savvy investors an opportunity. 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. So this free visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.

Of course you might be able to find a better stock than Vtech Holdings. So you may wish to see this free collection of other companies that have grown earnings strongly.

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.

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. Thank you for reading.