Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll show how you can use AMVIG Holdings Limited's (HKG:2300) P/E ratio to inform your assessment of the investment opportunity. AMVIG Holdings has a P/E ratio of 6.02, based on the last twelve months. In other words, at today's prices, investors are paying HK$6.02 for every HK$1 in prior year profit.

View our latest analysis for AMVIG Holdings

How Do I Calculate A Price To Earnings Ratio?

The formula for P/E is:

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

Or for AMVIG Holdings:

P/E of 6.02 = HK$1.88 ÷ HK$0.31 (Based on the year to June 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.

How Does AMVIG Holdings's P/E Ratio Compare To Its Peers?

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 AMVIG Holdings has a lower P/E than the average (12.6) in the packaging industry classification.

Its relatively low P/E ratio indicates that AMVIG Holdings shareholders think it will struggle to do as well as other companies in its industry classification. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.

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. That means even if the current P/E is high, it will reduce over time if the share price stays flat. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.

AMVIG Holdings's earnings per share fell by 13% in the last twelve months. But EPS is up 27% over the last 3 years. And it has shrunk its earnings per share by 5.2% per year over the last five years. This growth rate might warrant a below average P/E ratio.

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. That means it doesn't take debt or cash into account. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.

Such expenditure might be good or bad, in the long term, but the point here is that the balance sheet is not reflected by this ratio.

How Does AMVIG Holdings's Debt Impact Its P/E Ratio?

AMVIG Holdings has net debt equal to 34% of its market cap. While that's enough to warrant consideration, it doesn't really concern us.

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

AMVIG Holdings has a P/E of 6.0. That's below the average in the HK market, which is 10.2. Since it only carries a modest debt load, it's likely the low expectations implied by the P/E ratio arise from the lack of recent earnings growth.

Investors have an opportunity when market expectations about a stock are wrong. 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. We don't have analyst forecasts, but you might want to assess this data-rich visualization of earnings, revenue and cash flow.

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

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.