This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We'll look at Greentown Service Group Co. Ltd.'s (HKG:2869) P/E ratio and reflect on what it tells us about the company's share price. Greentown Service Group has a price to earnings ratio of 54.79, based on the last twelve months. That is equivalent to an earnings yield of about 1.8%.

Check out our latest analysis for Greentown Service Group

How Do You Calculate Greentown Service Group's P/E Ratio?

The formula for price to earnings is:

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

Or for Greentown Service Group:

P/E of 54.79 = CN¥9.409 ÷ CN¥0.172 (Based on the year to December 2019.)

(Note: the above calculation uses the share price in the reporting currency, namely CNY and the calculation results may not be precise due to rounding.)

Is A High Price-to-Earnings Ratio Good?

A higher P/E ratio means that investors are paying a higher price for each CN¥1 of company 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 Greentown Service Group's P/E Ratio Compare To Its Peers?

The P/E ratio indicates whether the market has higher or lower expectations of a company. As you can see below, Greentown Service Group has a much higher P/E than the average company (11.0) in the commercial services industry.

That means that the market expects Greentown Service Group will outperform other companies in its industry. The market is optimistic about the future, but that doesn't guarantee future growth. So further research is always essential. I often monitor director buying and selling.

How Growth Rates Impact P/E Ratios

Earnings growth rates have a big influence on P/E ratios. 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.

Greentown Service Group saw earnings per share decrease by 1.3% last year. But it has grown its earnings per share by 18% per year over the last five years.

A Limitation: P/E Ratios Ignore Debt and Cash In The Bank

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).

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.

So What Does Greentown Service Group's Balance Sheet Tell Us?

With net cash of CN¥2.7b, Greentown Service Group has a very strong balance sheet, which may be important for its business. Having said that, at 10% of its market capitalization the cash hoard would contribute towards a higher P/E ratio.

The Verdict On Greentown Service Group's P/E Ratio

With a P/E ratio of 54.8, Greentown Service Group is expected to grow earnings very strongly in the years to come. The recent drop in earnings per share might keep value investors away, but the relatively strong balance sheet will allow the company time to invest in growth. Clearly, the high P/E indicates shareholders think it will!

Investors should be looking to buy stocks that the market is wrong about. As value investor Benjamin Graham famously said, 'In the short run, the market is a voting machine but in the long run, it is a weighing machine. 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 find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.

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.