The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We'll show how you can use Pacific Basin Shipping Limited's (HKG:2343) P/E ratio to inform your assessment of the investment opportunity. Looking at earnings over the last twelve months, Pacific Basin Shipping has a P/E ratio of 18.54. That corresponds to an earnings yield of approximately 5.4%.

View our latest analysis for Pacific Basin Shipping

How Do You Calculate A P/E Ratio?

The formula for P/E is:

Price to Earnings Ratio = Share Price (in reporting currency) ÷ Earnings per Share (EPS)

Or for Pacific Basin Shipping:

P/E of 18.54 = HK$0.21 (Note: this is the share price in the reporting currency, namely, USD ) ÷ HK$0.01 (Based on the year to June 2019.)

Is A High Price-to-Earnings Ratio Good?

A higher P/E ratio means that buyers have to pay a higher price for each HK$1 the company has earned over the last year. 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 Pacific Basin Shipping Have A Relatively High Or Low P/E For Its Industry?

One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. As you can see below, Pacific Basin Shipping has a higher P/E than the average company (12.9) in the shipping industry.

That means that the market expects Pacific Basin Shipping will outperform other companies in its industry. The market is optimistic about the future, but that doesn't guarantee future growth. So investors should delve deeper. I like to check if company insiders have been buying or selling.

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. 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.

Pacific Basin Shipping increased earnings per share by 2.7% last year.

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

It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. 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.

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.

Is Debt Impacting Pacific Basin Shipping's P/E?

Pacific Basin Shipping has net debt worth 70% of its market capitalization. This is enough debt that you'd have to make some adjustments before using the P/E ratio to compare it to a company with net cash.

The Bottom Line On Pacific Basin Shipping's P/E Ratio

Pacific Basin Shipping trades on a P/E ratio of 18.5, which is above its market average of 10.1. With significant debt and fairly modest EPS growth last year, shareholders are betting on sustained improvement.

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. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.

You might be able to find a better buy than Pacific Basin Shipping. 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.

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