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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 Qingdao Port International Co., Ltd.'s (HKG:6198) P/E ratio to inform your assessment of the investment opportunity. Qingdao Port International has a price to earnings ratio of 7.58, based on the last twelve months. In other words, at today's prices, investors are paying HK$7.58 for every HK$1 in prior year profit.

Check out our latest analysis for Qingdao Port International

How Do You Calculate Qingdao Port International's P/E Ratio?

The formula for P/E is:

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

Or for Qingdao Port International:

P/E of 7.58 = CN¥4.55 (Note: this is the share price in the reporting currency, namely, CNY ) ÷ CN¥0.60 (Based on the year to March 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. All else being equal, it's better to pay a low price -- but as Warren Buffett said, 'It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price.'

How Growth Rates Impact P/E Ratios

Probably the most important factor in determining what P/E a company trades on is the earnings growth. That's because companies that grow earnings per share quickly will rapidly increase the 'E' in the equation. And in that case, the P/E ratio itself will drop rather quickly. Then, a lower P/E should attract more buyers, pushing the share price up.

Qingdao Port International increased earnings per share by an impressive 16% over the last twelve months. And it has bolstered its earnings per share by 8.0% per year over the last five years. This could arguably justify a relatively high P/E ratio.

How Does Qingdao Port International'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. We can see in the image below that the average P/E (8.8) for companies in the infrastructure industry is higher than Qingdao Port International's P/E.

Qingdao Port International's P/E tells us that market participants think it will not fare as well as its peers in the same industry. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. You should delve deeper. I like to check if company insiders have been buying or selling.

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

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.

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.

So What Does Qingdao Port International's Balance Sheet Tell Us?

Qingdao Port International has net cash of CN¥10b. This is fairly high at 22% 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 Qingdao Port International's P/E Ratio

Qingdao Port International has a P/E of 7.6. That's below the average in the HK market, which is 10.7. The net cash position gives plenty of options to the business, and the recent improvement in EPS is good to see. One might conclude that the market is a bit pessimistic, given the low P/E ratio.

Investors have an opportunity when market expectations about a stock are wrong. If the reality for a company is not as bad as the P/E ratio indicates, then the share price should increase as the market realizes this. 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.

You might be able to find a better buy than Qingdao Port International. 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).

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.