Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. To keep it practical, we'll show how Tokyo Chuo Auction Holdings Limited's (HKG:1939) P/E ratio could help you assess the value on offer. Based on the last twelve months, Tokyo Chuo Auction Holdings's P/E ratio is 11.51. That means that at current prices, buyers pay HK$11.51 for every HK$1 in trailing yearly profits.

View our latest analysis for Tokyo Chuo Auction Holdings

How Do You Calculate A P/E Ratio?

The formula for P/E is:

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

Or for Tokyo Chuo Auction Holdings:

P/E of 11.51 = HK$0.66 ÷ HK$0.06 (Based on the year to September 2019.)

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 necessarily good or bad, but a high P/E implies relatively high expectations of what a company can achieve in the future.

Does Tokyo Chuo Auction Holdings Have A Relatively High Or Low P/E For Its Industry?

The P/E ratio indicates whether the market has higher or lower expectations of a company. The image below shows that Tokyo Chuo Auction Holdings has a lower P/E than the average (14.5) P/E for companies in the consumer services industry.

Tokyo Chuo Auction 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 Tokyo Chuo Auction Holdings, it's quite possible it could surprise on the upside. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.

How Growth Rates Impact P/E Ratios

P/E ratios primarily reflect market expectations around earnings growth rates. Earnings growth means that in the future the 'E' will be higher. That means unless the share price increases, the P/E will reduce in a few years. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.

Tokyo Chuo Auction Holdings's earnings per share fell by 13% in the last twelve months.

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. In theory, a company can lower its future P/E ratio by using cash or debt to invest in 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.

Is Debt Impacting Tokyo Chuo Auction Holdings's P/E?

Tokyo Chuo Auction Holdings has net cash of HK$143m. This is fairly high at 43% of its market capitalization. That might mean balance sheet strength is important to the business, but should also help push the P/E a bit higher than it would otherwise be.

The Verdict On Tokyo Chuo Auction Holdings's P/E Ratio

Tokyo Chuo Auction Holdings has a P/E of 11.5. That's higher than the average in its market, which is 10.1. Falling earnings per share is probably keeping traditional value investors away, but the healthy balance sheet means the company retains potential for future growth. If fails to eventuate, the current high P/E could prove to be temporary, as the share price falls.

When the market is wrong about a stock, it gives savvy investors an opportunity. People often underestimate remarkable growth -- so investors can make money when fast growth is not fully appreciated. Although we don't have analyst forecasts you could get a better understanding of its growth by checking out this more detailed historical graph of earnings, revenue and cash flow.

But note: Tokyo Chuo Auction Holdings may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).

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.