This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We'll apply a basic P/E ratio analysis to China Life Insurance Company Limited's (HKG:2628), to help you decide if the stock is worth further research. Looking at earnings over the last twelve months, China Life Insurance has a P/E ratio of 15.59. That means that at current prices, buyers pay HK$15.59 for every HK$1 in trailing yearly profits.

See our latest analysis for China Life Insurance

How Do I Calculate China Life Insurance's Price To Earnings Ratio?

The formula for P/E is:

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

Or for China Life Insurance:

P/E of 15.59 = HK$17.75 (Note: this is the share price in the reporting currency, namely, CNY ) ÷ HK$1.14 (Based on the trailing twelve months to June 2019.)

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 Does China Life Insurance'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 China Life Insurance has a higher P/E than the average (10.3) P/E for companies in the insurance industry.

China Life Insurance's P/E tells us that market participants think the company will perform better than its industry peers, going forward. Shareholders are clearly optimistic, but the future is always uncertain. So investors should delve deeper. I like to check if company insiders have been buying or selling.

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. That's because companies that grow earnings per share quickly will rapidly increase the 'E' in the equation. And in that case, the P/E ratio itself will drop rather quickly. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.

China Life Insurance's earnings per share fell by 11% in the last twelve months. But over the longer term (5 years) earnings per share have increased by 3.6%.

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

Don't forget that the P/E ratio considers market capitalization. That means it doesn't take debt or cash into account. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.