This article is written for those who want to get better at using price to earnings ratios (P/E ratios). To keep it practical, we'll show how Huadian Power International Corporation Limited's (HKG:1071) P/E ratio could help you assess the value on offer. What is Huadian Power International's P/E ratio? Well, based on the last twelve months it is 11.73. That means that at current prices, buyers pay HK$11.73 for every HK$1 in trailing yearly profits.

See our latest analysis for Huadian Power International

How Do You Calculate Huadian Power International's P/E Ratio?

The formula for P/E is:

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

Or for Huadian Power International:

P/E of 11.73 = CNY2.56 (Note: this is the share price in the reporting currency, namely, CNY ) ÷ CNY0.22 (Based on the trailing twelve months to September 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 CNY1 the company has earned over the last year. That isn't a good or a bad thing on its own, but a high P/E means that buyers have a higher opinion of the business's prospects, relative to stocks with a lower P/E.

How Does Huadian Power International's P/E Ratio Compare To Its Peers?

We can get an indication of market expectations by looking at the P/E ratio. The image below shows that Huadian Power International has a higher P/E than the average (8.2) P/E for companies in the renewable energy industry.

Its relatively high P/E ratio indicates that Huadian Power International shareholders think it will perform better than other companies in its industry classification. The market is optimistic about the future, but that doesn't guarantee future growth. So investors should delve deeper. I like to check if company insiders have been buying or selling.

How Growth Rates Impact P/E Ratios

If earnings fall then in the future the 'E' will be lower. 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.

Huadian Power International's earnings per share fell by 4.7% in the last twelve months. And it has shrunk its earnings per share by 22% per year over the last five years. So it would be surprising to see a high P/E.

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

It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. So it won't reflect the advantage of cash, or disadvantage of debt. 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 Huadian Power International's Balance Sheet Tell Us?

Huadian Power International's net debt is considerable, at 331% of its market cap. 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 Huadian Power International's P/E Ratio

Huadian Power International trades on a P/E ratio of 11.7, which is above its market average of 10.4. With relatively high debt, and no earnings per share growth over twelve months, it's safe to say the market believes the company will improve its earnings growth 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. So this free report on the analyst consensus forecasts could help you make a master move on this stock.

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.

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