This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). To keep it practical, we’ll show how Zhaojin Mining Industry Company Limited’s (HKG:1818) P/E ratio could help you assess the value on offer. Zhaojin Mining Industry has a P/E ratio of 39.54, based on the last twelve months. In other words, at today’s prices, investors are paying HK$39.54 for every HK$1 in prior year profit.

See our latest analysis for Zhaojin Mining Industry

How Do You Calculate Zhaojin Mining Industry’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 Zhaojin Mining Industry:

P/E of 39.54 = CN¥6.74 (Note: this is the share price in the reporting currency, namely, CNY ) ÷ CN¥0.17 (Based on the year to June 2018.)

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 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. 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. A lower P/E should indicate the stock is cheap relative to others — and that may attract buyers.

Zhaojin Mining Industry increased earnings per share by 4.2% last year. And earnings per share have improved by 22% annually, over the last three years. Unfortunately, earnings per share are down 22% a year, over 5 years.

How Does Zhaojin Mining Industry’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 (8.1) for companies in the metals and mining industry is a lot lower than Zhaojin Mining Industry’s P/E.

Zhaojin Mining Industry’s P/E tells us that market participants think the company will perform better than its industry peers, going forward. 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.

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. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.

Such spending might be good or bad, overall, but the key point here is that you need to look at debt to understand the P/E ratio in context.

Zhaojin Mining Industry’s Balance Sheet

Zhaojin Mining Industry’s net debt is 57% of its market cap. If you want to compare its P/E ratio to other companies, you should absolutely keep in mind it has significant borrowings.

The Verdict On Zhaojin Mining Industry’s P/E Ratio

Zhaojin Mining Industry trades on a P/E ratio of 39.5, which is multiples above the HK market average of 10.6. With relatively high debt, and reasonably modest earnings per share growth over twelve months, it’s safe to say the market believes the company will improve its growth in the future.

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 report on the analyst consensus forecasts could help you make a master move on this stock.

Of course you might be able to find a better stock than Zhaojin Mining Industry. So you may wish to see this free collection of other companies that have grown earnings strongly.

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.