This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We'll apply a basic P/E ratio analysis to Pacific Textiles Holdings Limited's (HKG:1382), to help you decide if the stock is worth further research. Based on the last twelve months, Pacific Textiles Holdings's P/E ratio is 9.62. In other words, at today's prices, investors are paying HK$9.62 for every HK$1 in prior year profit.

Check out our latest analysis for Pacific Textiles Holdings

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 Pacific Textiles Holdings:

P/E of 9.62 = HK$5.73 ÷ HK$0.60 (Based on the year to March 2019.)

Is A High P/E Ratio Good?

The higher the P/E ratio, the higher the price tag of a business, relative to its trailing 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.

How Does Pacific Textiles Holdings's P/E Ratio Compare To Its Peers?

The P/E ratio essentially measures market expectations of a company. The image below shows that Pacific Textiles Holdings has a P/E ratio that is roughly in line with the luxury industry average (9.3).

Pacific Textiles Holdings's P/E tells us that market participants think its prospects are roughly in line with its industry. If the company has better than average prospects, then the market might be underestimating it. Checking factors such as director buying and selling. could help you form your own view on if that will happen.

How Growth Rates Impact P/E Ratios

If earnings fall then in the future the 'E' will be lower. That means unless the share price falls, the P/E will increase in a few years. So while a stock may look cheap based on past earnings, it could be expensive based on future earnings.

It's great to see that Pacific Textiles Holdings grew EPS by 16% in the last year. Unfortunately, earnings per share are down 5.1% a year, over 5 years.

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

The 'Price' in P/E reflects the market capitalization of the company. So it won't reflect the advantage of cash, or disadvantage of debt. In theory, a company can lower its future P/E ratio by using cash or debt to invest in 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.

Is Debt Impacting Pacific Textiles Holdings's P/E?

Since Pacific Textiles Holdings holds net cash of HK$275m, it can spend on growth, justifying a higher P/E ratio than otherwise.

The Bottom Line On Pacific Textiles Holdings's P/E Ratio

Pacific Textiles Holdings has a P/E of 9.6. That's around the same as the average in the HK market, which is 10.3. The balance sheet is healthy, and recent EPS growth impressive, but the P/E implies some caution from the market.

Investors should be looking to buy stocks that the market is wrong about. 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. 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 Pacific Textiles Holdings. So you may wish to see this free collection of other companies that have grown earnings strongly.

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.

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. Thank you for reading.