This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We'll show how you can use Charmacy Pharmaceutical Co., Ltd.'s (HKG:2289) P/E ratio to inform your assessment of the investment opportunity. Charmacy Pharmaceutical has a price to earnings ratio of 15.59, based on the last twelve months. That corresponds to an earnings yield of approximately 6.4%.

Check out our latest analysis for Charmacy Pharmaceutical

How Do I Calculate A Price To Earnings Ratio?

The formula for P/E is:

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

Or for Charmacy Pharmaceutical:

P/E of 15.59 = CNY6.08 (Note: this is the share price in the reporting currency, namely, CNY ) ÷ CNY0.39 (Based on the trailing twelve months to June 2019.)

Is A High P/E Ratio Good?

A higher P/E ratio implies that investors pay a higher price for the earning power of the business. 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 Does Charmacy Pharmaceutical'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 Charmacy Pharmaceutical has a P/E ratio that is roughly in line with the healthcare industry average (16.0).

Charmacy Pharmaceutical's P/E tells us that market participants think its prospects are roughly in line with its industry. The company could surprise by performing better than average, in the future. Further research into factors such as insider buying and selling, could help you form your own view on whether that is likely.

How Growth Rates Impact P/E Ratios

If earnings fall then in the future the 'E' will be lower. That means even if the current P/E is low, it will increase over time if the share price stays flat. So while a stock may look cheap based on past earnings, it could be expensive based on future earnings.

Charmacy Pharmaceutical's earnings per share fell by 11% in the last twelve months.

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

It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. So it won't reflect the advantage of cash, or disadvantage of debt. Theoretically, a business can improve its earnings (and produce a lower P/E in the future) by investing in growth. That means taking on debt (or spending its 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.

So What Does Charmacy Pharmaceutical's Balance Sheet Tell Us?

Net debt totals 69% of Charmacy Pharmaceutical's market cap. This is enough debt that you'd have to make some adjustments before using the P/E ratio to compare it to a company with net cash.

The Verdict On Charmacy Pharmaceutical's P/E Ratio

Charmacy Pharmaceutical's P/E is 15.6 which is above average (10.6) in its market. With meaningful debt and a lack of recent earnings growth, the market has high expectations that the business will earn more in the future.

Investors have an opportunity when market expectations about a stock are wrong. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. Although we don't have analyst forecasts you might want to assess this data-rich visualization of earnings, revenue and cash flow.

Of course you might be able to find a better stock than Charmacy Pharmaceutical. 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.