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 Amara Holdings Limited's (SGX:A34) P/E ratio could help you assess the value on offer. What is Amara Holdings's P/E ratio? Well, based on the last twelve months it is 6.84. That means that at current prices, buyers pay SGD6.84 for every SGD1 in trailing yearly profits.

See our latest analysis for Amara Holdings

How Do I Calculate A Price To Earnings Ratio?

The formula for P/E is:

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

Or for Amara Holdings:

P/E of 6.84 = SGD0.335 ÷ SGD0.049 (Based on the year to December 2019.)

(Note: the above calculation results may not be precise due to rounding.)

Is A High Price-to-Earnings Ratio Good?

The higher the P/E ratio, the higher the price tag of a business, relative to its trailing 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 Does Amara Holdings's P/E Ratio Compare To Its Peers?

The P/E ratio essentially measures market expectations of a company. If you look at the image below, you can see Amara Holdings has a lower P/E than the average (16.8) in the hospitality industry classification.

Amara Holdings's P/E tells us that market participants think it will not fare as well as its peers in the same industry. Since the market seems unimpressed with Amara Holdings, it's quite possible it could surprise on the upside. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.

How Growth Rates Impact P/E Ratios

When earnings fall, the 'E' decreases, over time. 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.

Amara Holdings shrunk earnings per share by 12% over the last year. And it has shrunk its earnings per share by 4.3% per year over the last five years. This might lead to muted expectations.

Remember: P/E Ratios Don't Consider The Balance Sheet

Don't forget that the P/E ratio considers market capitalization. So it won't reflect the advantage of cash, or disadvantage of debt. 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.