This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We'll look at Sinopec Shanghai Petrochemical Company Limited's (HKG:338) P/E ratio and reflect on what it tells us about the company's share price. Sinopec Shanghai Petrochemical has a P/E ratio of 5.51, based on the last twelve months. In other words, at today's prices, investors are paying HK$5.51 for every HK$1 in prior year profit.

Check out our latest analysis for Sinopec Shanghai Petrochemical

How Do You Calculate Sinopec Shanghai Petrochemical's P/E Ratio?

The formula for price to earnings is:

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

Or for Sinopec Shanghai Petrochemical:

P/E of 5.51 = CN¥2.09 (Note: this is the share price in the reporting currency, namely, CNY ) ÷ CN¥0.38 (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. That isn't a good or a bad thing on its own, but a high P/E means that buyers have a higher opinion of the business's prospects, relative to stocks with a lower P/E.

How Does Sinopec Shanghai Petrochemical's P/E Ratio Compare To Its Peers?

The P/E ratio indicates whether the market has higher or lower expectations of a company. The image below shows that Sinopec Shanghai Petrochemical has a lower P/E than the average (7) P/E for companies in the chemicals industry.

Its relatively low P/E ratio indicates that Sinopec Shanghai Petrochemical shareholders think it will struggle to do as well as other companies in its industry classification. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. You should delve deeper. I like to check if company insiders have been buying or selling.

How Growth Rates Impact P/E Ratios

When earnings fall, the 'E' decreases, over time. Therefore, even if you pay a low multiple of earnings now, that multiple will become higher in the future. Then, a higher P/E might scare off shareholders, pushing the share price down.

Sinopec Shanghai Petrochemical shrunk earnings per share by 31% over the last year. But EPS is up 18% over the last 5 years. And EPS is down 1.6% a year, over the last 3 years. This growth rate might warrant a low P/E ratio.

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

Don't forget that the P/E ratio considers market capitalization. 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.