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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 CL Educate Limited's (NSE:CLEDUCATE) P/E ratio could help you assess the value on offer. CL Educate has a P/E ratio of 12.73, based on the last twelve months. That is equivalent to an earnings yield of about 7.9%.
Check out our latest analysis for CL Educate
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 CL Educate:
P/E of 12.73 = ₹118.8 ÷ ₹9.33 (Based on the trailing twelve months to December 2018.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio means that buyers have to pay a higher price for each ₹1 the company has earned over the last year. That isn't a good or a bad thing on its own, but a high P/E means that buyers have a higher opinion of the business's prospects, relative to stocks with a lower P/E.
How Growth Rates Impact P/E Ratios
When earnings fall, the 'E' decreases, over time. Therefore, even if you pay a low multiple of earnings now, that multiple will become higher in the future. A higher P/E should indicate the stock is expensive relative to others -- and that may encourage shareholders to sell.
CL Educate shrunk earnings per share by 9.3% last year. And over the longer term (5 years) earnings per share have decreased 11% annually. So we might expect a relatively low P/E.
How Does CL Educate's P/E Ratio Compare To Its Peers?
The P/E ratio indicates whether the market has higher or lower expectations of a company. We can see in the image below that the average P/E (21.5) for companies in the consumer services industry is higher than CL Educate's P/E.
CL Educate'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 CL Educate, it's quite possible it could surprise on the upside. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and selling.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
Don't forget that the P/E ratio considers market capitalization. So it won't reflect the advantage of cash, or disadvantage of debt. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.
Such spending might be good or bad, overall, but the key point here is that you need to look at debt to understand the P/E ratio in context.