This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We'll apply a basic P/E ratio analysis to Great Eagle Holdings Limited's (HKG:41), to help you decide if the stock is worth further research. What is Great Eagle Holdings's P/E ratio? Well, based on the last twelve months it is 4.16. That is equivalent to an earnings yield of about 24.0%.

Check out our latest analysis for Great Eagle Holdings

How Do You Calculate Great Eagle Holdings's P/E Ratio?

The formula for P/E is:

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

Or for Great Eagle Holdings:

P/E of 4.16 = HK$26.70 ÷ HK$6.41 (Based on the trailing twelve months 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 isn't necessarily good or bad, but a high P/E implies relatively high expectations of what a company can achieve in the future.

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

The P/E ratio essentially measures market expectations of a company. We can see in the image below that the average P/E (7.0) for companies in the real estate industry is higher than Great Eagle Holdings's P/E.

This suggests that market participants think Great Eagle Holdings 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

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. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.

Great Eagle Holdings's earnings per share fell by 49% in the last twelve months. But EPS is up 21% over the last 5 years.

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. In other words, it does not consider any debt or cash that the company may have on the balance sheet. 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.

Great Eagle Holdings's Balance Sheet

Great Eagle Holdings has net debt worth a very significant 109% of its market capitalization. If you want to compare its P/E ratio to other companies, you must keep in mind that these debt levels would usually warrant a relatively low P/E.

The Verdict On Great Eagle Holdings's P/E Ratio

Great Eagle Holdings has a P/E of 4.2. That's below the average in the HK market, which is 10.7. The P/E reflects market pessimism that probably arises from the lack of recent EPS growth, paired with significant leverage.

Investors have an opportunity when market expectations about a stock are wrong. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. So this free visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.

You might be able to find a better buy than Great Eagle Holdings. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).

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.

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. Thank you for reading.