This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). To keep it practical, we'll show how Kunlun Energy Company Limited's (HKG:135) P/E ratio could help you assess the value on offer. Kunlun Energy has a price to earnings ratio of 10.85, based on the last twelve months. That corresponds to an earnings yield of approximately 9.2%.

Check out our latest analysis for Kunlun Energy

How Do You Calculate Kunlun Energy's P/E 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 Kunlun Energy:

P/E of 10.85 = HK$6.30 (Note: this is the share price in the reporting currency, namely, CNY ) ÷ HK$0.58 (Based on the trailing twelve months to June 2019.)

Is A High P/E Ratio Good?

A higher P/E ratio means that investors are paying a higher price for each HK$1 of company earnings. 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 Kunlun Energy Have A Relatively High Or Low P/E For Its Industry?

The P/E ratio essentially measures market expectations of a company. The image below shows that Kunlun Energy has a lower P/E than the average (17.1) P/E for companies in the gas utilities industry.

Kunlun Energy's P/E tells us that market participants think it will not fare as well as its peers in the same industry. Since the market seems unimpressed with Kunlun Energy, it's quite possible it could surprise on the upside. 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

Probably the most important factor in determining what P/E a company trades on is the earnings growth. That's because companies that grow earnings per share quickly will rapidly increase the 'E' in the equation. That means unless the share price increases, the P/E will reduce in a few years. And as that P/E ratio drops, the company will look cheap, unless its share price increases.

Kunlun Energy's earnings per share fell by 12% in the last twelve months. But it has grown its earnings per share by 53% per year over the last three years. And EPS is down 1.7% a year, over the last 5 years. This might lead to muted expectations.

Remember: P/E Ratios Don't Consider The Balance Sheet

One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. 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 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.

So What Does Kunlun Energy's Balance Sheet Tell Us?

Kunlun Energy's net debt equates to 33% of its market capitalization. While it's worth keeping this in mind, it isn't a worry.

The Verdict On Kunlun Energy's P/E Ratio

Kunlun Energy has a P/E of 10.9. That's around the same as the average in the HK market, which is 10.7. With modest debt, and a lack of recent growth, it would seem the market is expecting improvement in earnings.

Investors have an opportunity when market expectations about a stock are wrong. People often underestimate remarkable growth -- so investors can make money when fast growth is not fully appreciated. 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.

Of course you might be able to find a better stock than Kunlun Energy. So you may wish to see this free collection of other companies that have grown earnings strongly.

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.