The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We'll show how you can use Kwoon Chung Bus Holdings Limited's (HKG:306) P/E ratio to inform your assessment of the investment opportunity. Kwoon Chung Bus Holdings has a P/E ratio of 5.95, based on the last twelve months. In other words, at today's prices, investors are paying HK$5.95 for every HK$1 in prior year profit.

View our latest analysis for Kwoon Chung Bus Holdings

How Do I Calculate A Price To Earnings Ratio?

The formula for P/E is:

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

Or for Kwoon Chung Bus Holdings:

P/E of 5.95 = HK$2.70 ÷ HK$0.45 (Based on the trailing twelve months to September 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 Kwoon Chung Bus Holdings'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 Kwoon Chung Bus Holdings has a lower P/E than the average (19.7) P/E for companies in the transportation industry.

This suggests that market participants think Kwoon Chung Bus Holdings will underperform other companies in its industry. Since the market seems unimpressed with Kwoon Chung Bus Holdings, it's quite possible it could surprise on the upside. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.

How Growth Rates Impact P/E Ratios

If earnings fall then in the future the 'E' will be lower. 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.

Kwoon Chung Bus Holdings saw earnings per share improve by -4.1% last year. And it has bolstered its earnings per share by 2.4% per year over the last five years. But earnings per share are down 17% per year over the last three years.

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

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.

While growth expenditure doesn't always pay off, the point is that it is a good option to have; but one that the P/E ratio ignores.

So What Does Kwoon Chung Bus Holdings's Balance Sheet Tell Us?

Kwoon Chung Bus Holdings has net debt worth a very significant 121% 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 Bottom Line On Kwoon Chung Bus Holdings's P/E Ratio

Kwoon Chung Bus Holdings's P/E is 6.0 which is below average (10.3) in the HK market. It's good to see EPS growth in the last 12 months, but the debt on the balance sheet might be muting expectations.

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. We don't have analyst forecasts, but you might want to assess this data-rich visualization of earnings, revenue and cash flow.

You might be able to find a better buy than Kwoon Chung Bus 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.