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This article is written for those who want to get better at using price to earnings ratios (P/E ratios). To keep it practical, we'll show how Yangtze Optical Fibre And Cable Joint Stock Limited Company's (HKG:6869) P/E ratio could help you assess the value on offer. Yangtze Optical Fibre And Cable Limited has a P/E ratio of 8.83, based on the last twelve months. That means that at current prices, buyers pay HK$8.83 for every HK$1 in trailing yearly profits.

View our latest analysis for Yangtze Optical Fibre And Cable Limited

How Do You Calculate Yangtze Optical Fibre And Cable Limited'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 Yangtze Optical Fibre And Cable Limited:

P/E of 8.83 = CN¥18.44 (Note: this is the share price in the reporting currency, namely, CNY ) ÷ CN¥2.09 (Based on the year to December 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 is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.

How Growth Rates Impact P/E Ratios

Earnings growth rates have a big influence on P/E ratios. 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. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.

Yangtze Optical Fibre And Cable Limited increased earnings per share by an impressive 12% over the last twelve months. And earnings per share have improved by 22% annually, over the last five years. So one might expect an above average P/E ratio.

How Does Yangtze Optical Fibre And Cable Limited'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 Yangtze Optical Fibre And Cable Limited has a lower P/E than the average (13) P/E for companies in the communications industry.

Yangtze Optical Fibre And Cable Limited's P/E tells us that market participants think it will not fare as well as its peers in the same industry. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and selling.

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

The 'Price' in P/E reflects the market capitalization of the company. That means it doesn't take debt or cash into account. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.

Such expenditure might be good or bad, in the long term, but the point here is that the balance sheet is not reflected by this ratio.

How Does Yangtze Optical Fibre And Cable Limited's Debt Impact Its P/E Ratio?

Since Yangtze Optical Fibre And Cable Limited holds net cash of CN¥1.4b, it can spend on growth, justifying a higher P/E ratio than otherwise.

The Verdict On Yangtze Optical Fibre And Cable Limited's P/E Ratio

Yangtze Optical Fibre And Cable Limited's P/E is 8.8 which is below average (12.2) in the HK market. The net cash position gives plenty of options to the business, and the recent improvement in EPS is good to see. The below average P/E ratio suggests that market participants don't believe the strong growth will continue.

Investors should be looking to buy stocks that the market is wrong about. If the reality for a company is not as bad as the P/E ratio indicates, then the share price should increase as the market realizes this. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.

Of course you might be able to find a better stock than Yangtze Optical Fibre And Cable Limited. So you may wish to see this free collection of other companies that have grown earnings strongly.

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.

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. Thank you for reading.