This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We'll look at Xinyi Solar Holdings Limited's (HKG:968) P/E ratio and reflect on what it tells us about the company's share price. Xinyi Solar Holdings has a P/E ratio of 23.88, based on the last twelve months. In other words, at today's prices, investors are paying HK$23.88 for every HK$1 in prior year profit.

See our latest analysis for Xinyi Solar Holdings

How Do You Calculate Xinyi Solar Holdings's P/E Ratio?

The formula for price to earnings is:

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

Or for Xinyi Solar Holdings:

P/E of 23.88 = HK$4.95 ÷ HK$0.21 (Based on the year to June 2019.)

Is A High Price-to-Earnings Ratio Good?

A higher P/E ratio means that investors are paying a higher price for each HK$1 of company earnings. 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 Does Xinyi Solar 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. You can see in the image below that the average P/E (15.4) for companies in the semiconductor industry is lower than Xinyi Solar Holdings's P/E.

Its relatively high P/E ratio indicates that Xinyi Solar Holdings shareholders think it will perform better than other companies in its industry classification. Clearly the market expects growth, but it isn't guaranteed. So investors should delve deeper. I like to check if company insiders have been buying or selling.

How Growth Rates Impact P/E Ratios

When earnings fall, the 'E' decreases, over time. 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.

Xinyi Solar Holdings shrunk earnings per share by 33% over the last year. But over the longer term (5 years) earnings per share have increased by 21%. And over the longer term (3 years) earnings per share have decreased 6.9% annually. This might lead to low expectations.

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

It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. Thus, the metric does not reflect cash or debt held by the company. 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.

How Does Xinyi Solar Holdings's Debt Impact Its P/E Ratio?

Xinyi Solar Holdings's net debt is 8.8% of its market cap. So it doesn't have as many options as it would with net cash, but its debt would not have much of an impact on its P/E ratio.

The Verdict On Xinyi Solar Holdings's P/E Ratio

Xinyi Solar Holdings's P/E is 23.9 which is above average (10) in its market. With modest debt but no EPS growth in the last year, it's fair to say the P/E implies some optimism about future earnings, from the market.

When the market is wrong about a stock, it gives savvy investors an opportunity. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. So this free report on the analyst consensus forecasts could help you make a master move on this stock.

Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.

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.