Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. To keep it practical, we'll show how Embry Holdings Limited's (HKG:1388) P/E ratio could help you assess the value on offer. Looking at earnings over the last twelve months, Embry Holdings has a P/E ratio of 6.09. That is equivalent to an earnings yield of about 16%.

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See our latest analysis for Embry Holdings

How Do I Calculate A Price To Earnings Ratio?

The formula for P/E is:

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

Or for Embry Holdings:

P/E of 6.09 = HK$2.18 ÷ HK$0.36 (Based on the year to December 2018.)

Is A High P/E 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. 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

When earnings fall, the 'E' decreases, over time. That means even if the current P/E is low, it will increase over time if the share price stays flat. Then, a higher P/E might scare off shareholders, pushing the share price down.

Embry Holdings saw earnings per share decrease by 70% last year. And EPS is down 5.5% a year, over the last 5 years. This might lead to muted expectations.

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

We can get an indication of market expectations by looking at the P/E ratio. If you look at the image below, you can see Embry Holdings has a lower P/E than the average (10.4) in the luxury industry classification.

Embry Holdings's P/E tells us that market participants think it will not fare as well as its peers in the same industry. Many investors like to buy stocks when the market is pessimistic about their prospects. You should delve deeper. I like to check if company insiders have been buying or selling.

Remember: P/E Ratios Don't Consider The Balance Sheet

The 'Price' in P/E reflects the market capitalization of the company. In other words, it does not consider any debt or cash that the company may have on the balance sheet. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.

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 Embry Holdings's Balance Sheet Tell Us?

Embry Holdings has net debt equal to 27% of its market cap. You'd want to be aware of this fact, but it doesn't bother us.