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 China Travel International Investment Hong Kong Limited's (HKG:308) P/E ratio could help you assess the value on offer. China Travel International Investment Hong Kong has a P/E ratio of 10.73, based on the last twelve months. That means that at current prices, buyers pay HK$10.73 for every HK$1 in trailing yearly profits.

See our latest analysis for China Travel International Investment Hong Kong

How Do You Calculate A P/E Ratio?

The formula for price to earnings is:

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

Or for China Travel International Investment Hong Kong:

P/E of 10.73 = HK$1.43 ÷ HK$0.13 (Based on the year to June 2019.)

Is A High P/E 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.

How Does China Travel International Investment Hong Kong'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 (12.0) for companies in the hospitality industry is higher than China Travel International Investment Hong Kong's P/E.

This suggests that market participants think China Travel International Investment Hong Kong will underperform other companies in its industry. Since the market seems unimpressed with China Travel International Investment Hong Kong, it's quite possible it could surprise on the upside. You should delve deeper. I like to check if company insiders have been buying or selling.

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. When earnings grow, the 'E' increases, over time. And in that case, the P/E ratio itself will drop rather quickly. And as that P/E ratio drops, the company will look cheap, unless its share price increases.

China Travel International Investment Hong Kong saw earnings per share decrease by 37% last year. But over the longer term (3 years), earnings per share have increased by 10%. And it has shrunk its earnings per share by 13% per year over the last five years. This could justify a pessimistic P/E.

Don't Forget: The P/E Does Not Account For Debt or Bank Deposits

The 'Price' in P/E reflects the market capitalization of the company. Thus, the metric does not reflect cash or debt held by the company. The exact same company would hypothetically deserve a higher P/E ratio if it had a strong balance sheet, than if it had a weak one with lots of debt, because a cashed up company can spend on 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.

How Does China Travel International Investment Hong Kong's Debt Impact Its P/E Ratio?

With net cash of HK$3.7b, China Travel International Investment Hong Kong has a very strong balance sheet, which may be important for its business. Having said that, at 47% of its market capitalization the cash hoard would contribute towards a higher P/E ratio.

The Bottom Line On China Travel International Investment Hong Kong's P/E Ratio

China Travel International Investment Hong Kong trades on a P/E ratio of 10.7, which is fairly close to the HK market average of 10.6. While the lack of recent growth is probably muting optimism, the net cash position means it's not surprising that expectations put the company roughly in line with the market average P/E.

When the market is wrong about a stock, it gives savvy investors an opportunity. As value investor Benjamin Graham famously said, 'In the short run, the market is a voting machine but in the long run, it is a weighing machine. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.

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.