Want to participate in a short research study? Help shape the future of investing tools and you could win a $250 gift card!

Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll apply a basic P/E ratio analysis to China Tianrui Group Cement Company Limited's (HKG:1252), to help you decide if the stock is worth further research. Looking at earnings over the last twelve months, China Tianrui Group Cement has a P/E ratio of 14.2. That corresponds to an earnings yield of approximately 7.0%.

See our latest analysis for China Tianrui Group Cement

How Do I Calculate China Tianrui Group Cement's Price To Earnings Ratio?

The formula for price to earnings is:

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

Or for China Tianrui Group Cement:

P/E of 14.2 = CN¥5.86 (Note: this is the share price in the reporting currency, namely, CNY ) ÷ CN¥0.41 (Based on the year to December 2018.)

Is A High Price-to-Earnings Ratio Good?

The higher the P/E ratio, the higher the price tag of a business, relative to its trailing earnings. 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 China Tianrui Group Cement 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 China Tianrui Group Cement has a higher P/E than the average (6.4) P/E for companies in the basic materials industry.

That means that the market expects China Tianrui Group Cement will outperform other companies in its industry. The market is optimistic about the future, but that doesn't guarantee future growth. So investors should delve deeper. I like to check if company insiders have been buying or selling.

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. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. 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.

China Tianrui Group Cement increased earnings per share by an impressive 11% over the last twelve months. And earnings per share have improved by 12% annually, over the last five years. So one might expect an above average P/E ratio.

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

One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. Thus, the metric does not reflect cash or debt held by the company. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.

Spending on growth might be good or bad a few years later, but the point is that the P/E ratio does not account for the option (or lack thereof).

Is Debt Impacting China Tianrui Group Cement's P/E?

China Tianrui Group Cement has net debt worth 52% of its market capitalization. This is enough debt that you'd have to make some adjustments before using the P/E ratio to compare it to a company with net cash.

The Verdict On China Tianrui Group Cement's P/E Ratio

China Tianrui Group Cement trades on a P/E ratio of 14.2, which is above its market average of 10.8. It has already proven it can grow earnings, but the debt levels mean it faces some risks. The relatively high P/E ratio suggests shareholders think growth will continue.

When the market is wrong about a stock, it gives savvy investors an opportunity. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. Although we don't have analyst forecasts, you could get a better understanding of its growth by checking out this more detailed historical graph of earnings, revenue and cash flow.

But note: China Tianrui Group Cement may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).

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.

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. Thank you for reading.