This article is written for those who want to get better at using price to earnings ratios (P/E ratios). To keep it practical, we'll show how KangLi International Holdings Limited's (HKG:6890) P/E ratio could help you assess the value on offer. Looking at earnings over the last twelve months, KangLi International Holdings has a P/E ratio of 10.33. That corresponds to an earnings yield of approximately 9.7%.

Check out our latest analysis for KangLi International Holdings

How Do I Calculate A Price To Earnings Ratio?

The formula for price to earnings is:

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

Or for KangLi International Holdings:

P/E of 10.33 = HK$0.92 (Note: this is the share price in the reporting currency, namely, CNY ) ÷ HK$0.09 (Based on the year to June 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 is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.

Does KangLi International 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. You can see in the image below that the average P/E (10.9) for companies in the metals and mining industry is roughly the same as KangLi International Holdings's P/E.

That indicates that the market expects KangLi International Holdings will perform roughly in line with other companies in its industry. If the company has better than average prospects, then the market might be underestimating it. Further research into factors such as insider buying and selling, could help you form your own view on whether that is likely.

How Growth Rates Impact P/E Ratios

Probably the most important factor in determining what P/E a company trades on is the earnings growth. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. Then, a lower P/E should attract more buyers, pushing the share price up.

KangLi International Holdings's earnings per share fell by 31% in the last twelve months.

A Limitation: P/E Ratios Ignore Debt and Cash In The Bank

The 'Price' in P/E reflects the market capitalization of the company. So it won't reflect the advantage of cash, or disadvantage of debt. 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.