The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We'll apply a basic P/E ratio analysis to Luye Pharma Group Ltd.'s (HKG:2186), to help you decide if the stock is worth further research. Looking at earnings over the last twelve months, Luye Pharma Group has a P/E ratio of 10.99. In other words, at today's prices, investors are paying HK$10.99 for every HK$1 in prior year profit.

Check out our latest analysis for Luye Pharma Group

How Do You Calculate Luye Pharma Group's P/E Ratio?

The formula for P/E is:

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

Or for Luye Pharma Group:

P/E of 10.99 = HK$5.17 (Note: this is the share price in the reporting currency, namely, CNY ) ÷ HK$0.47 (Based on the trailing twelve months to June 2019.)

Is A High Price-to-Earnings 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 a good or a bad thing on its own, but a high P/E means that buyers have a higher opinion of the business's prospects, relative to stocks with a lower P/E.

How Does Luye Pharma Group's P/E Ratio Compare To Its Peers?

The P/E ratio essentially measures market expectations of a company. As you can see below Luye Pharma Group has a P/E ratio that is fairly close for the average for the pharmaceuticals industry, which is 10.9.

Luye Pharma Group's P/E tells us that market participants think its prospects are roughly in line with its industry. The company could surprise by performing better than average, in the future. Checking factors such as director buying and selling. could help you form your own view on if that will happen.

How Growth Rates Impact P/E Ratios

Generally speaking the rate of earnings growth has a profound impact on a company's P/E multiple. When earnings grow, the 'E' increases, over time. 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.

Notably, Luye Pharma Group grew EPS by a whopping 31% in the last year. And it has bolstered its earnings per share by 31% per year over the last five years. With that performance, I would expect it to have an above average P/E ratio.

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

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. 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.

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.

Luye Pharma Group's Balance Sheet

Luye Pharma Group has net debt worth 13% of its market capitalization. It would probably deserve a higher P/E ratio if it was net cash, since it would have more options for growth.

The Bottom Line On Luye Pharma Group's P/E Ratio

Luye Pharma Group has a P/E of 11.0. That's higher than the average in its market, which is 10.1. While the company does use modest debt, its recent earnings growth is superb. So to be frank we are not surprised it has a high P/E ratio.

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.

You might be able to find a better buy than Luye Pharma Group. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).

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.