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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 apply a basic P/E ratio analysis to Hindalco Industries Limited's (NSE:HINDALCO), to help you decide if the stock is worth further research. Looking at earnings over the last twelve months, Hindalco Industries has a P/E ratio of 8.08. That is equivalent to an earnings yield of about 12%.
View our latest analysis for Hindalco Industries
How Do I Calculate Hindalco Industries's Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Hindalco Industries:
P/E of 8.08 = ₹184.5 ÷ ₹22.83 (Based on the year to June 2019.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio implies that investors pay a higher price for the earning power of the business. 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 Does Hindalco Industries's P/E Ratio Compare To Its Peers?
The P/E ratio indicates whether the market has higher or lower expectations of a company. As you can see below Hindalco Industries has a P/E ratio that is fairly close for the average for the metals and mining industry, which is 8.2.
Its P/E ratio suggests that Hindalco Industries shareholders think that in the future it will perform about the same as other companies in its industry classification. If the company has better than average prospects, then the market might be underestimating it. Checking factors such as director buying and selling. could help you form your own view on if that will happen.
How Growth Rates Impact P/E Ratios
P/E ratios primarily reflect market expectations around earnings growth rates. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. 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.
Hindalco Industries's earnings per share fell by 14% in the last twelve months. But it has grown its earnings per share by 16% per year over the last five years.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
Don't forget that the P/E ratio considers market capitalization. So it won't reflect the advantage of cash, or disadvantage of debt. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
While growth expenditure doesn't always pay off, the point is that it is a good option to have; but one that the P/E ratio ignores.