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The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We’ll show how you can use Fire Rock Holdings Limited’s (HKG:8345) P/E ratio to inform your assessment of the investment opportunity. Fire Rock Holdings has a P/E ratio of 18.46, based on the last twelve months. That corresponds to an earnings yield of approximately 5.4%.

View our latest analysis for Fire Rock Holdings

How Do I Calculate A Price To Earnings Ratio?

The formula for price to earnings is:

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

Or for Fire Rock Holdings:

P/E of 18.46 = CN¥4.4 (Note: this is the share price in the reporting currency, namely, CNY ) ÷ CN¥0.24 (Based on the year to September 2018.)

Is A High P/E Ratio Good?

A higher P/E ratio means that investors are paying a higher price for each HK$1 of company earnings. 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

Probably the most important factor in determining what P/E a company trades on is the earnings growth. That’s because companies that grow earnings per share quickly will rapidly increase the ‘E’ in the equation. That means even if the current P/E is high, it will reduce over time if the share price stays flat. Then, a lower P/E should attract more buyers, pushing the share price up.

Notably, Fire Rock Holdings grew EPS by a whopping 97% in the last year. And its annual EPS growth rate over 5 years is 40%. With that performance, I would expect it to have an above average P/E ratio.

How Does Fire Rock Holdings’s P/E Ratio Compare To Its Peers?

The P/E ratio indicates whether the market has higher or lower expectations of a company. You can see in the image below that the average P/E (12.3) for companies in the entertainment industry is lower than Fire Rock Holdings’s P/E.

Its relatively high P/E ratio indicates that Fire Rock Holdings 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 delve deeper. I like to check if company insiders have been buying or selling.

Don’t Forget: The P/E Does Not Account For Debt or Bank Deposits

Don’t forget that the P/E ratio considers market capitalization. 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.