This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We'll show how you can use WINDMILL Group Limited's (HKG:1850) P/E ratio to inform your assessment of the investment opportunity. WINDMILL Group has a P/E ratio of 13.42, based on the last twelve months. That corresponds to an earnings yield of approximately 7.4%.

See our latest analysis for WINDMILL Group

How Do I Calculate A Price To Earnings Ratio?

The formula for price to earnings is:

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

Or for WINDMILL Group:

P/E of 13.42 = HK$0.32 ÷ HK$0.024 (Based on the trailing twelve months to April 2019.)

Is A High Price-to-Earnings 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.

Does WINDMILL Group 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 WINDMILL Group has a P/E ratio that is roughly in line with the commercial services industry average (12.6).

That indicates that the market expects WINDMILL Group will perform roughly in line with other companies in 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

When earnings fall, the 'E' decreases, over time. That means unless the share price falls, the P/E will increase in a few years. Then, a higher P/E might scare off shareholders, pushing the share price down.

WINDMILL Group's earnings per share fell by 21% in the last twelve months. And over the longer term (3 years) earnings per share have decreased 7.9% annually. This might lead to low expectations.

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. The exact same company would hypothetically deserve a higher P/E ratio if it had a strong balance sheet, than if it had a weak one with lots of debt, because a cashed up company can spend on growth.

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 WINDMILL Group's P/E?

Since WINDMILL Group holds net cash of HK$12m, it can spend on growth, justifying a higher P/E ratio than otherwise.

The Verdict On WINDMILL Group's P/E Ratio

WINDMILL Group has a P/E of 13.4. That's higher than the average in its market, which is 9.8. The recent drop in earnings per share might keep value investors away, but the healthy balance sheet means the company retains potential for future growth. If fails to eventuate, the current high P/E could prove to be temporary, as the share price falls.

Investors should be looking to buy stocks that the market is wrong about. 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 might want to assess this data-rich visualization of earnings, revenue and cash flow.

You might be able to find a better buy than WINDMILL Group. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).

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.