The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). To keep it practical, we'll show how Noble Engineering Group Holdings Limited's (HKG:8445) P/E ratio could help you assess the value on offer. What is Noble Engineering Group Holdings's P/E ratio? Well, based on the last twelve months it is 6.94. That corresponds to an earnings yield of approximately 14%.

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View our latest analysis for Noble Engineering Group Holdings

How Do I Calculate A Price To Earnings Ratio?

The formula for price to earnings is:

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

Or for Noble Engineering Group Holdings:

P/E of 6.94 = HK$0.28 ÷ HK$0.040 (Based on the trailing twelve months to December 2018.)

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. 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. Earnings growth means that in the future the 'E' will be higher. That means unless the share price increases, the P/E will reduce in a few years. And as that P/E ratio drops, the company will look cheap, unless its share price increases.

In the last year, Noble Engineering Group Holdings grew EPS like Taylor Swift grew her fan base back in 2010; the 70% gain was both fast and well deserved. Having said that, if we look back three years, EPS growth has averaged a comparatively less impressive 10%.

How Does Noble Engineering Group Holdings's P/E Ratio Compare To Its Peers?

The P/E ratio essentially measures market expectations of a company. The image below shows that Noble Engineering Group Holdings has a lower P/E than the average (11.8) P/E for companies in the construction industry.

Its relatively low P/E ratio indicates that Noble Engineering Group Holdings shareholders think it will struggle to do as well as other companies in its industry classification. Many investors like to buy stocks when the market is pessimistic about their prospects. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and 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. 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.

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.

So What Does Noble Engineering Group Holdings's Balance Sheet Tell Us?

With net cash of HK$27m, Noble Engineering Group Holdings has a very strong balance sheet, which may be important for its business. Having said that, at 15% of its market capitalization the cash hoard would contribute towards a higher P/E ratio.

The Verdict On Noble Engineering Group Holdings's P/E Ratio

Noble Engineering Group Holdings trades on a P/E ratio of 6.9, which is below the HK market average of 11.1. The net cash position gives plenty of options to the business, and the recent improvement in EPS is good to see. The below average P/E ratio suggests that market participants don't believe the strong growth will continue.

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

Of course you might be able to find a better stock than Noble Engineering Group Holdings. So you may wish to see this free collection of other companies that have grown earnings strongly.

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.