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 Jacobson Pharma Corporation Limited's (HKG:2633) P/E ratio to inform your assessment of the investment opportunity. Looking at earnings over the last twelve months, Jacobson Pharma has a P/E ratio of 9.17. That is equivalent to an earnings yield of about 10.9%.

Check out our latest analysis for Jacobson Pharma

How Do You Calculate A P/E Ratio?

The formula for price to earnings is:

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

Or for Jacobson Pharma:

P/E of 9.17 = HK$1.19 ÷ HK$0.13 (Based on the trailing twelve months to March 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 Jacobson Pharma's P/E Ratio Compare To Its Peers?

The P/E ratio indicates whether the market has higher or lower expectations of a company. We can see in the image below that the average P/E (11.6) for companies in the pharmaceuticals industry is higher than Jacobson Pharma's P/E.

This suggests that market participants think Jacobson Pharma will underperform other companies in its industry. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and selling.

How Growth Rates Impact P/E Ratios

P/E ratios primarily reflect market expectations around earnings growth rates. That's because companies that grow earnings per share quickly will rapidly increase the 'E' in the equation. That means even if the current P/E is high, it will reduce over time if the share price stays flat. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.

Most would be impressed by Jacobson Pharma earnings growth of 16% in the last year. And its annual EPS growth rate over 3 years is 5.3%. So one might expect an above average P/E ratio. In contrast, EPS has decreased by 1.8%, annually, over 5 years.

Don't Forget: The P/E Does Not Account For Debt or Bank Deposits

It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. That means it doesn't take debt or cash into account. 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.

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.

Jacobson Pharma's Balance Sheet

Net debt is 25% of Jacobson Pharma's market cap. While that's enough to warrant consideration, it doesn't really concern us.

The Bottom Line On Jacobson Pharma's P/E Ratio

Jacobson Pharma's P/E is 9.2 which is below average (10.3) in the HK market. The company does have a little debt, and EPS growth was good last year. The low P/E ratio suggests current market expectations are muted, implying these levels of growth will not continue. Because analysts are predicting more growth in the future, one might have expected to see a higher P/E ratio. You can take a closer look at the fundamentals, here.

When the market is wrong about a stock, it gives savvy investors an opportunity. If the reality for a company is not as bad as the P/E ratio indicates, then the share price should increase as the market realizes this. So this free report on the analyst consensus forecasts could help you make a master move on this stock.

Of course you might be able to find a better stock than Jacobson Pharma. 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.