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 China Evergrande Group's (HKG:3333) P/E ratio could help you assess the value on offer. China Evergrande Group has a price to earnings ratio of 5.55, based on the last twelve months. That corresponds to an earnings yield of approximately 18%.

See our latest analysis for China Evergrande Group

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

The formula for P/E is:

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

Or for China Evergrande Group:

P/E of 5.55 = CN¥15.8 (Note: this is the share price in the reporting currency, namely, CNY ) ÷ CN¥2.85 (Based on the year to December 2018.)

Is A High Price-to-Earnings Ratio Good?

A higher P/E ratio means that investors are paying a higher price for each HK$1 of company earnings. 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 Does China Evergrande Group's P/E Ratio Compare To Its Peers?

The P/E ratio essentially measures market expectations of a company. As you can see below China Evergrande Group has a P/E ratio that is fairly close for the average for the real estate industry, which is 5.9.

Its P/E ratio suggests that China Evergrande Group shareholders think that in the future it will perform about the same as other companies in its industry classification. So if China Evergrande Group actually outperforms its peers going forward, that should be a positive for the share price. I would further inform my view by checking insider buying and selling., among other things.

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 unless the share price increases, the P/E will reduce in a few years. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.

China Evergrande Group's 55% EPS improvement over the last year was like bamboo growth after rain; rapid and impressive. The cherry on top is that the five year growth rate was an impressive 29% per year. So I'd be surprised if the P/E ratio was not above average.

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. Theoretically, a business can improve its earnings (and produce a lower P/E in the future) by investing in growth. That means taking on debt (or spending its cash).