This article is written for those who want to get better at using price to earnings ratios (P/E ratios). To keep it practical, we’ll show how Hindcon Chemicals Limited’s (NSE:HINDCON) P/E ratio could help you assess the value on offer. Hindcon Chemicals has a price to earnings ratio of 2.13, based on the last twelve months. That corresponds to an earnings yield of approximately 47%.

Check out our latest analysis for Hindcon Chemicals

How Do You Calculate A P/E Ratio?

The formula for price to earnings is:

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

Or for Hindcon Chemicals:

P/E of 2.13 = ₹19.45 ÷ ₹9.12 (Based on the trailing twelve months to March 2018.)

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 isn’t necessarily good or bad, but a high P/E implies relatively high expectations of what a company can achieve in the future.

How Growth Rates Impact P/E Ratios

P/E ratios primarily reflect market expectations around earnings growth rates. That’s because companies that grow earnings per share quickly will rapidly increase the ‘E’ in the equation. That means even if the current P/E is high, it will reduce over time if the share price stays flat. Then, a lower P/E should attract more buyers, pushing the share price up.

It’s nice to see that Hindcon Chemicals grew EPS by a stonking 88% in the last year. And its annual EPS growth rate over 5 years is 51%. I’d therefore be a little surprised if its P/E ratio was not relatively high.

How Does Hindcon Chemicals’s P/E Ratio Compare To Its Peers?

The P/E ratio essentially measures market expectations of a company. The image below shows that Hindcon Chemicals has a lower P/E than the average (15.6) P/E for companies in the chemicals industry.

Its relatively low P/E ratio indicates that Hindcon Chemicals shareholders think it will struggle to do as well as other companies in its industry classification. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.

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

The ‘Price’ in P/E reflects the market capitalization of the company. Thus, the metric does not reflect cash or debt held by the company. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.