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 EVA Precision Industrial Holdings Limited's (HKG:838) P/E ratio could help you assess the value on offer. EVA Precision Industrial Holdings has a price to earnings ratio of 14.23, based on the last twelve months. That means that at current prices, buyers pay HK$14.23 for every HK$1 in trailing yearly profits.

See our latest analysis for EVA Precision Industrial Holdings

How Do I Calculate A Price To Earnings Ratio?

The formula for P/E is:

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

Or for EVA Precision Industrial Holdings:

P/E of 14.23 = HKD0.59 ÷ HKD0.04 (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 HKD1 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.

Does EVA Precision Industrial Holdings Have A Relatively High Or Low P/E For Its Industry?

We can get an indication of market expectations by looking at the P/E ratio. The image below shows that EVA Precision Industrial Holdings has a higher P/E than the average (10.3) P/E for companies in the machinery industry.

EVA Precision Industrial Holdings's P/E tells us that market participants think the company will perform better than its industry peers, going forward. Shareholders are clearly optimistic, but the future is always uncertain. So further research is always essential. I often monitor director buying and 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. A higher P/E should indicate the stock is expensive relative to others -- and that may encourage shareholders to sell.

EVA Precision Industrial Holdings saw earnings per share decrease by 29% last year. And EPS is down 14% a year, over the last 5 years. This could justify a pessimistic P/E.

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

Don't forget that the P/E ratio considers market capitalization. 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 spending might be good or bad, overall, but the key point here is that you need to look at debt to understand the P/E ratio in context.

How Does EVA Precision Industrial Holdings's Debt Impact Its P/E Ratio?

EVA Precision Industrial Holdings's net debt is 61% of its market cap. If you want to compare its P/E ratio to other companies, you should absolutely keep in mind it has significant borrowings.

The Verdict On EVA Precision Industrial Holdings's P/E Ratio

EVA Precision Industrial Holdings trades on a P/E ratio of 14.2, which is above its market average of 10.1. With meaningful debt and a lack of recent earnings growth, the market has high expectations that the business will earn more in the future.

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. We don't have analyst forecasts, but you might want to assess this data-rich visualization of earnings, revenue and cash flow.

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.

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.