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 KWG Group Holdings Limited's (HKG:1813) P/E ratio could help you assess the value on offer. KWG Group Holdings has a price to earnings ratio of 3.13, based on the last twelve months. That is equivalent to an earnings yield of about 31.9%.

View our latest analysis for KWG Group Holdings

How Do I Calculate KWG Group Holdings's 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 KWG Group Holdings:

P/E of 3.13 = HK$7.73 (Note: this is the share price in the reporting currency, namely, CNY ) ÷ HK$2.47 (Based on the trailing twelve months to June 2019.)

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 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 KWG Group Holdings's P/E Ratio Compare To Its Peers?

We can get an indication of market expectations by looking at the P/E ratio. The image below shows that KWG Group Holdings has a lower P/E than the average (6.7) P/E for companies in the real estate industry.

KWG Group Holdings's P/E tells us that market participants think it will not fare as well as its peers in the same industry. Since the market seems unimpressed with KWG Group Holdings, it's quite possible it could surprise on the upside. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and selling.

How Growth Rates Impact P/E Ratios

Earnings growth rates have a big influence on P/E ratios. Earnings growth means that in the future the 'E' will be higher. And in that case, the P/E ratio itself will drop rather quickly. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.

KWG Group Holdings's earnings made like a rocket, taking off 83% last year. The cherry on top is that the five year growth rate was an impressive 21% per year. With that kind of growth rate we would generally expect a high P/E ratio.

A Limitation: P/E Ratios Ignore Debt and Cash In The Bank

One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. That means it doesn't take debt or cash into account. 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.

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 KWG Group Holdings's Debt Impact Its P/E Ratio?

KWG Group Holdings's net debt is considerable, at 124% of its market cap. This is a relatively high level of debt, so the stock probably deserves a relatively low P/E ratio. Keep that in mind when comparing it to other companies.

The Verdict On KWG Group Holdings's P/E Ratio

KWG Group Holdings's P/E is 3.1 which is below average (10.1) in the HK market. While the EPS growth last year was strong, the significant debt levels reduce the number of options available to management. If it continues to grow, then the current low P/E may prove to be unjustified.

Investors have an opportunity when market expectations about a stock are wrong. 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 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 KWG Group Holdings. 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.