Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll show how you can use K. Wah International Holdings Limited's (HKG:173) P/E ratio to inform your assessment of the investment opportunity. K. Wah International Holdings has a P/E ratio of 2.71, based on the last twelve months. That is equivalent to an earnings yield of about 36.9%.

Check out our latest analysis for K. Wah International Holdings

How Do You Calculate K. Wah International Holdings's P/E Ratio?

The formula for P/E is:

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

Or for K. Wah International Holdings:

P/E of 2.71 = HK$4.29 ÷ HK$1.58 (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 necessarily good or bad, but a high P/E implies relatively high expectations of what a company can achieve in the future.

How Does K. Wah International Holdings's P/E Ratio Compare To Its Peers?

One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. The image below shows that K. Wah International Holdings has a lower P/E than the average (6.7) P/E for companies in the real estate industry.

K. Wah International Holdings's P/E tells us that market participants think it will not fare as well as its peers in the same industry. Many investors like to buy stocks when the market is pessimistic about their prospects. 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

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. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. And as that P/E ratio drops, the company will look cheap, unless its share price increases.

K. Wah International Holdings's earnings made like a rocket, taking off 111% last year. The sweetener is that the annual five year growth rate of 35% is also impressive. 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

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 investing in growth. That means taking on debt (or spending its cash).

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.

How Does K. Wah International Holdings's Debt Impact Its P/E Ratio?

Net debt totals 71% of K. Wah International Holdings's market cap. This is a reasonably significant level of debt -- all else being equal you'd expect a much lower P/E than if it had net cash.

The Bottom Line On K. Wah International Holdings's P/E Ratio

K. Wah International Holdings has a P/E of 2.7. That's below the average in the HK market, which is 10.1. While the EPS growth last year was strong, the significant debt levels reduce the number of options available to management. The low P/E ratio suggests current market expectations are muted, implying these levels of growth will not continue.

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

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

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.