The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We'll apply a basic P/E ratio analysis to Shenzhen International Holdings Limited's (HKG:152), to help you decide if the stock is worth further research. Based on the last twelve months, Shenzhen International Holdings's P/E ratio is 6.20. That means that at current prices, buyers pay HK$6.20 for every HK$1 in trailing yearly profits.

See our latest analysis for Shenzhen International Holdings

How Do I Calculate Shenzhen International Holdings's Price To Earnings Ratio?

The formula for P/E is:

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

Or for Shenzhen International Holdings:

P/E of 6.20 = HK$14.540 ÷ HK$2.344 (Based on the year to December 2019.)

(Note: the above calculation results may not be precise due to rounding.)

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.

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

One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. The image below shows that Shenzhen International Holdings has a P/E ratio that is roughly in line with the infrastructure industry average (6.6).

That indicates that the market expects Shenzhen International Holdings will perform roughly in line with other companies in its industry. So if Shenzhen International Holdings actually outperforms its peers going forward, that should be a positive for the share price. 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

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. And in that case, the P/E ratio itself will drop rather quickly. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.

It's great to see that Shenzhen International Holdings grew EPS by 15% in the last year. And its annual EPS growth rate over 5 years is 12%. So one might expect an above average P/E ratio.

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

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. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.

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.

Shenzhen International Holdings's Balance Sheet

Net debt is 42% of Shenzhen International Holdings's market cap. While that's enough to warrant consideration, it doesn't really concern us.

The Verdict On Shenzhen International Holdings's P/E Ratio

Shenzhen International Holdings has a P/E of 6.2. That's below the average in the HK market, which is 9.5. The company hasn't stretched its balance sheet, and earnings growth was good last year. If it continues to grow, then the current low P/E may prove to be unjustified.

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. 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.

But note: Shenzhen International Holdings may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).

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.