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This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We'll show how you can use Kwan On Holdings Limited's (HKG:1559) P/E ratio to inform your assessment of the investment opportunity. Based on the last twelve months, Kwan On Holdings's P/E ratio is 21.19. That means that at current prices, buyers pay HK$21.19 for every HK$1 in trailing yearly profits.

See our latest analysis for Kwan On Holdings

How Do You Calculate A P/E Ratio?

The formula for price to earnings is:

Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)

Or for Kwan On Holdings:

P/E of 21.19 = HK$0.58 ÷ HK$0.027 (Based on the year to September 2018.)

Is A High Price-to-Earnings Ratio Good?

A higher P/E ratio implies that investors pay a higher price for the earning power of the business. 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 Growth Rates Impact P/E Ratios

Companies that shrink earnings per share quickly will rapidly decrease the 'E' in the equation. That means even if the current P/E is low, it will increase over time if the share price stays flat. So while a stock may look cheap based on past earnings, it could be expensive based on future earnings.

Kwan On Holdings increased earnings per share by 7.3% last year. And earnings per share have improved by 3.5% annually, over the last five years. Unfortunately, earnings per share are down 6.2% a year, over 3 years.

How Does Kwan On 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. The image below shows that Kwan On Holdings has a higher P/E than the average (12.6) P/E for companies in the construction industry.

Kwan On Holdings'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 always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.

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

The 'Price' in P/E reflects the market capitalization of the company. In other words, it does not consider any debt or cash that the company may have on the balance sheet. Theoretically, a business can improve its earnings (and produce a lower P/E in the future), by taking on debt (or spending its remaining cash).