The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). To keep it practical, we'll show how Shui On Land Limited's (HKG:272) P/E ratio could help you assess the value on offer. What is Shui On Land's P/E ratio? Well, based on the last twelve months it is 5.83. That corresponds to an earnings yield of approximately 17.2%.

See our latest analysis for Shui On Land

How Do I Calculate Shui On Land's 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 Shui On Land:

P/E of 5.83 = CNY1.45 (Note: this is the share price in the reporting currency, namely, CNY ) ÷ CNY0.25 (Based on the year to June 2019.)

Is A High Price-to-Earnings 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 Shui On Land's P/E Ratio Compare To Its Peers?

The P/E ratio essentially measures market expectations of a company. If you look at the image below, you can see Shui On Land has a lower P/E than the average (6.4) in the real estate industry classification.

Shui On Land'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 Shui On Land, it's quite possible it could surprise on the upside. You should delve deeper. I like to check if company insiders have been buying or selling.

How Growth Rates Impact P/E Ratios

Earnings growth rates have a big influence on P/E ratios. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.

Shui On Land maintained roughly steady earnings over the last twelve months. But over the longer term (5 years) earnings per share have increased by 1.3%.

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. 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.