China Tonghai International Financial (HKG:952) shareholders are no doubt pleased to see that the share price has had a great month, posting a 38% gain, recovering from prior weakness. But shareholders may not all be feeling jubilant, since the share price is still down 41% in the last year.

All else being equal, a sharp share price increase should make a stock less attractive to potential investors. While the market sentiment towards a stock is very changeable, in the long run, the share price will tend to move in the same direction as earnings per share. So some would prefer to hold off buying when there is a lot of optimism towards a stock. One way to gauge market expectations of a stock is to look at its Price to Earnings Ratio (PE Ratio). A high P/E ratio means that investors have a high expectation about future growth, while a low P/E ratio means they have low expectations about future growth.

See our latest analysis for China Tonghai International Financial

Does China Tonghai International Financial Have A Relatively High Or Low P/E For Its Industry?

We can tell from its P/E ratio of 22.78 that there is some investor optimism about China Tonghai International Financial. As you can see below, China Tonghai International Financial has a higher P/E than the average company (12.4) in the capital markets industry.

China Tonghai International Financial's P/E tells us that market participants think the company will perform better than its industry peers, going forward. Clearly the market expects growth, but it isn't guaranteed. So investors should delve deeper. I like to check if company insiders have been buying or 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. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.

It's nice to see that China Tonghai International Financial grew EPS by a stonking 27% in the last year. And earnings per share have improved by 97% annually, over the last three years. With that performance, I would expect it to have an above average P/E ratio. But earnings per share are down 6.3% per year over the last five years.

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. Thus, the metric does not reflect cash or debt held by the company. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.