The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We'll look at City Union Bank Ltd.'s (NSE:CUB) P/E ratio and reflect on what it tells us about the company's share price. Based on the last twelve months, City Union Bank's P/E ratio is 20.75. In other words, at today's prices, investors are paying ₹20.75 for every ₹1 in prior year profit.

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View our latest analysis for City Union Bank

How Do I Calculate City Union Bank's Price To Earnings Ratio?

The formula for P/E is:

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

Or for City Union Bank:

P/E of 20.75 = ₹198.6 ÷ ₹9.57 (Based on the year to March 2019.)

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 Growth Rates Impact P/E Ratios

P/E ratios primarily reflect market expectations around earnings growth rates. When earnings grow, the 'E' increases, over time. That means unless the share price increases, the P/E will reduce in a few years. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.

It's great to see that City Union Bank grew EPS by 15% in the last year. And its annual EPS growth rate over 5 years is 12%. This could arguably justify a relatively high P/E ratio.

How Does City Union Bank's P/E Ratio Compare To Its Peers?

The P/E ratio essentially measures market expectations of a company. We can see in the image below that the average P/E (29.8) for companies in the banks industry is higher than City Union Bank's P/E.

This suggests that market participants think City Union Bank will underperform other companies in its industry. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. You should delve deeper. I like to check if company insiders have been buying or selling.

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

The 'Price' in P/E reflects the market capitalization of the company. In other words, it does not consider any debt or cash that the company may have on the balance sheet. 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).