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This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We'll look at Bajaj Auto Limited's (NSE:BAJAJ-AUTO) P/E ratio and reflect on what it tells us about the company's share price. Based on the last twelve months, Bajaj Auto's P/E ratio is 17.47. In other words, at today's prices, investors are paying ₹17.47 for every ₹1 in prior year profit.
Check out our latest analysis for Bajaj Auto
How Do You Calculate Bajaj Auto's P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Bajaj Auto:
P/E of 17.47 = ₹2957.50 ÷ ₹169.29 (Based on the trailing twelve months to June 2019.)
Is A High P/E Ratio Good?
The higher the P/E ratio, the higher the price tag of a business, relative to its trailing earnings. That is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.
Does Bajaj Auto Have A Relatively High Or Low P/E For Its Industry?
One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. You can see in the image below that the average P/E (16.0) for companies in the auto industry is lower than Bajaj Auto's P/E.
Its relatively high P/E ratio indicates that Bajaj Auto 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 further research is always essential. I often monitor director buying and selling.
How Growth Rates Impact P/E Ratios
Generally speaking the rate of earnings growth has a profound impact on a company's P/E multiple. That's because companies that grow earnings per share quickly will rapidly increase the 'E' in the equation. That means unless the share price increases, the P/E will reduce in a few years. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.
Most would be impressed by Bajaj Auto earnings growth of 11% in the last year. And earnings per share have improved by 7.7% annually, over the last five years. With that performance, you might expect an above average P/E ratio.
Remember: P/E Ratios Don't Consider The Balance Sheet
It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. 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).