This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We’ll look at IT Limited’s (HKG:999) P/E ratio and reflect on what it tells us about the company’s share price. Based on the last twelve months, I.T’s P/E ratio is 10.19. That is equivalent to an earnings yield of about 9.8%.

See our latest analysis for I.T

How Do You Calculate A P/E Ratio?

The formula for price to earnings is:

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

Or for I.T:

P/E of 10.19 = HK$4.12 ÷ HK$0.40 (Based on the year to August 2018.)

Is A High Price-to-Earnings Ratio Good?

A higher P/E ratio means that investors are paying a higher price for each HK$1 of company earnings. All else being equal, it’s better to pay a low price — but as Warren Buffett said, ‘It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.’

How Growth Rates Impact P/E Ratios

P/E ratios primarily reflect market expectations around earnings growth rates. Earnings growth means that in the future the ‘E’ will be higher. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. Then, a lower P/E should attract more buyers, pushing the share price up.

It’s nice to see that I.T grew EPS by a stonking 45% in the last year. And earnings per share have improved by 10% annually, over the last five years. So we’d generally expect it to have a relatively high P/E ratio.

How Does I.T’s P/E Ratio Compare To Its Peers?

The P/E ratio indicates whether the market has higher or lower expectations of a company. As you can see below, I.T has a higher P/E than the average company (8.9) in the specialty retail industry.

I.T’s P/E tells us that market participants think the company will perform better than its industry peers, going forward. Shareholders are clearly optimistic, but the future is always uncertain. So investors should delve deeper. I like to check if company insiders have been buying or selling.

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

The ‘Price’ in P/E reflects the market capitalization of the company. Thus, the metric does not reflect cash or debt held by the company. Theoretically, a business can improve its earnings (and produce a lower P/E in the future), by taking on debt (or spending its remaining cash).

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.