In This Article:
The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). To keep it practical, we’ll show how The Grob Tea Company Limited’s (NSE:GROBTEA) P/E ratio could help you assess the value on offer. Grob Tea has a price to earnings ratio of 47.13, based on the last twelve months. That is equivalent to an earnings yield of about 2.1%.
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How Do I Calculate A Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Grob Tea:
P/E of 47.13 = ₹585 ÷ ₹12.41 (Based on the trailing twelve months to September 2018.)
Is A High P/E 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 is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.
How Growth Rates Impact P/E Ratios
If earnings fall then in the future the ‘E’ will be lower. 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.
Grob Tea saw earnings per share decrease by 68% last year. And EPS is down 41% a year, over the last 5 years. This growth rate might warrant a below average P/E ratio.
How Does Grob Tea’s P/E Ratio Compare To Its Peers?
We can get an indication of market expectations by looking at the P/E ratio. The image below shows that Grob Tea has a higher P/E than the average (18.4) P/E for companies in the food industry.
Grob Tea’s P/E tells us that market participants think the company will perform better than its industry peers, going forward. Clearly the market expects growth, but it isn’t guaranteed. So investors should delve deeper. I like to check if company insiders have been buying or selling.
Don’t Forget: The P/E Does Not Account For Debt or Bank Deposits
The ‘Price’ in P/E reflects the market capitalization of the company. 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.
Such expenditure might be good or bad, in the long term, but the point here is that the balance sheet is not reflected by this ratio.