This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We'll show how you can use Qingdao Holdings International Limited's (HKG:499) P/E ratio to inform your assessment of the investment opportunity. Based on the last twelve months, Qingdao Holdings International's P/E ratio is 33.51. That is equivalent to an earnings yield of about 3.0%.

Check out our latest analysis for Qingdao Holdings International

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 Qingdao Holdings International:

P/E of 33.51 = HK$0.64 ÷ HK$0.019 (Based on the trailing twelve months to March 2019.)

Is A High Price-to-Earnings Ratio Good?

A higher P/E ratio implies that investors pay a higher price for the earning power of the business. 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 Qingdao Holdings International Have A Relatively High Or Low P/E For Its Industry?

The P/E ratio essentially measures market expectations of a company. The image below shows that Qingdao Holdings International has a significantly higher P/E than the average (6.3) P/E for companies in the real estate industry.

Qingdao Holdings International's P/E tells us that market participants think the company will perform better than its industry peers, going forward. The market is optimistic about the future, but that doesn't guarantee future growth. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.

How Growth Rates Impact P/E Ratios

Earnings growth rates have a big influence on P/E ratios. Earnings growth means that in the future the 'E' will be higher. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.

In the last year, Qingdao Holdings International grew EPS like Taylor Swift grew her fan base back in 2010; the 64% gain was both fast and well deserved. The sweetener is that the annual five year growth rate of 68% is also impressive. With that kind of growth rate we would generally expect a high P/E ratio.

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

One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. So it won't reflect the advantage of cash, or disadvantage of debt. Theoretically, a business can improve its earnings (and produce a lower P/E in the future) by investing in growth. That means taking on debt (or spending its cash).

Spending on growth might be good or bad a few years later, but the point is that the P/E ratio does not account for the option (or lack thereof).

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

Qingdao Holdings International has net debt worth a very significant 113% of its market capitalization. If you want to compare its P/E ratio to other companies, you must keep in mind that these debt levels would usually warrant a relatively low P/E.

The Bottom Line On Qingdao Holdings International's P/E Ratio

Qingdao Holdings International's P/E is 33.5 which is way above average (10.6) in its market. Its meaningful level of debt should warrant a lower P/E ratio, but the fast EPS growth is a positive. So it seems likely the market is overlooking the debt because of the fast earnings growth.

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.

You might be able to find a better buy than Qingdao Holdings 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.