The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We'll look at Time Watch Investments Limited's (HKG:2033) P/E ratio and reflect on what it tells us about the company's share price. Time Watch Investments has a P/E ratio of 5.59, based on the last twelve months. In other words, at today's prices, investors are paying HK$5.59 for every HK$1 in prior year profit.

See our latest analysis for Time Watch Investments

How Do I Calculate A Price To Earnings Ratio?

The formula for price to earnings is:

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

Or for Time Watch Investments:

P/E of 5.59 = HKD0.82 ÷ HKD0.15 (Based on the year to June 2019.)

Is A High Price-to-Earnings Ratio Good?

A higher P/E ratio implies that investors pay a higher price for the earning power of the business. That is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.

Does Time Watch Investments Have A Relatively High Or Low P/E For Its Industry?

The P/E ratio indicates whether the market has higher or lower expectations of a company. We can see in the image below that the average P/E (8.2) for companies in the luxury industry is higher than Time Watch Investments's P/E.

This suggests that market participants think Time Watch Investments will underperform other companies in its industry. Since the market seems unimpressed with Time Watch Investments, it's quite possible it could surprise on the upside. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and selling.

How Growth Rates Impact P/E Ratios

P/E ratios primarily reflect market expectations around earnings growth rates. That's because companies that grow earnings per share quickly will rapidly increase the 'E' in the equation. 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.

Time Watch Investments increased earnings per share by 4.8% last year. And it has improved its earnings per share by 1.0% per year over the last three years.

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

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. 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.