The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We’ll look at Jiayuan International Group Limited’s (HKG:2768) P/E ratio and reflect on what it tells us about the company’s share price. Based on the last twelve months, Jiayuan International Group’s P/E ratio is 16.63. That is equivalent to an earnings yield of about 6.0%.

See our latest analysis for Jiayuan International Group

How Do I Calculate Jiayuan International Group’s Price To Earnings Ratio?

The formula for P/E is:

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

Or for Jiayuan International Group:

P/E of 16.63 = CN¥12.45 (Note: this is the share price in the reporting currency, namely, CNY ) ÷ CN¥0.75 (Based on the trailing twelve months to June 2018.)

Is A High P/E Ratio Good?

A higher P/E ratio means that buyers have to pay a higher price for each HK$1 the company has earned over the last year. That isn’t necessarily good or bad, but a high P/E implies relatively high expectations of what a company can achieve in the future.

How Growth Rates Impact P/E Ratios

P/E ratios primarily reflect market expectations around earnings growth rates. Earnings growth means that in the future the ‘E’ will be higher. 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.

Jiayuan International Group increased earnings per share by a whopping 50% last year. And earnings per share have improved by 30% annually, over the last five years. I’d therefore be a little surprised if its P/E ratio was not relatively high.

How Does Jiayuan International Group’s P/E Ratio Compare To Its Peers?

We can get an indication of market expectations by looking at the P/E ratio. You can see in the image below that the average P/E (5.3) for companies in the real estate industry is a lot lower than Jiayuan International Group’s P/E.

Its relatively high P/E ratio indicates that Jiayuan International Group shareholders think it will perform better than other companies in its industry classification. The market is optimistic about the future, but that doesn’t guarantee future growth. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.

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

Don’t forget that the P/E ratio considers market capitalization. In other words, it does not consider any debt or cash that the company may have on the balance sheet. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.

Spending on growth might be good or bad a few years later, but the point is that the P/E ratio does not account for the option (or lack thereof).

Jiayuan International Group’s Balance Sheet

Net debt totals 24% of Jiayuan International Group’s market cap. This could bring some additional risk, and reduce the number of investment options for management; worth remembering if you compare its P/E to businesses without debt.

The Bottom Line On Jiayuan International Group’s P/E Ratio

Jiayuan International Group trades on a P/E ratio of 16.6, which is above the HK market average of 10.7. While the company does use modest debt, its recent earnings growth is impressive. So it does not seem strange that the P/E is above average.

When the market is wrong about a stock, it gives savvy investors an opportunity. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. We don’t have analyst forecasts, but shareholders might want to examine this detailed historical graph of earnings, revenue and cash flow.

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.

To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.