This d&d 3.5e character sheetarticle is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). To keep it practical, we'll show how World Precision Machinery Limited's (

SGX:B49

) P/E ratio could help you assess the value on offer.

World Precision Machinery has a price to earnings ratio of 17.89

, based on the last twelve months. That corresponds to an earnings yield of approximately 5.6%.

See our latest analysis for World Precision Machinery

How Do You Calculate A P/E Ratio?

The

formula for price to earnings

is:

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

Or for World Precision Machinery:

P/E of 17.89 = CN¥0.898 ÷ CN¥0.050 (Based on the year to December 2019.)

(Note: the above calculation uses the share price in the reporting currency, namely CNY and the calculation results may not be precise due to rounding.)

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. 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 Does World Precision Machinery'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. The image below shows that World Precision Machinery has a higher P/E than the average (8.4) P/E for companies in the machinery industry.

SGX:B49 Price Estimation Relative to Market May 4th 2020

That means that the market expects World Precision Machinery will outperform other companies in its industry. Shareholders are clearly optimistic, but the future is always uncertain. So further research is always essential. I often monitor

director buying and selling

.

How Growth Rates Impact P/E Ratios

If earnings fall then in the future the 'E' will be lower. That means unless the share price falls, the P/E will increase in a few years. So while a stock may look cheap based on past earnings, it could be expensive based on future earnings.

In the last year, World Precision Machinery grew EPS like Taylor Swift grew her fan base back in 2010; the 228% gain was both fast and well deserved. Regrettably, the longer term performance is poor, with EPS down 29% per year over 5 years.

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. 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.

Story continues

Such expenditure might be good or bad, in the long term, but the point here is that the balance sheet is not reflected by this ratio.

World Precision Machinery's Balance Sheet

The extra options and safety that comes with World Precision Machinery's CN¥8.7m net cash position means that it deserves a higher P/E than it would if it had a lot of net debt.

The Verdict On World Precision Machinery's P/E Ratio

World Precision Machinery's P/E is 17.9 which is above average (11.2) in its market. The excess cash it carries is the gravy on top its fast EPS growth. To us, this is the sort of company that we would expect to carry an above average price tag (relative to earnings).

Investors have an opportunity when market expectations about a stock are wrong. People often underestimate remarkable growth -- so investors can make money when fast growth is not fully appreciated. We don't have analyst forecasts, but you might want to assess

this data-rich visualization

of earnings, revenue and cash flow.

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

[email protected]

. 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.

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