What Does KSB Limited's (NSE:KSB) P/E Ratio Tell You?

Simply Wall St

Thu, Oct 10, 2019, 7:57 PM

Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll show how you can use KSB Limited's (NSE:KSB) P/E ratio to inform your assessment of the investment opportunity. Based on the last twelve months, KSB's P/E ratio is 26.39. That is equivalent to an earnings yield of about 3.8%.

Check out our latest analysis for KSB

How Do You Calculate KSB's P/E Ratio?

The formula for P/E is:

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

Or for KSB:

P/E of 26.39 = ₹653.05 ÷ ₹24.75 (Based on the trailing twelve months to June 2019.)

Is A High P/E Ratio Good?

A higher P/E ratio implies that investors pay a higher price for the earning power of the business. 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.

Does KSB Have A Relatively High Or Low P/E For Its Industry?

The P/E ratio indicates whether the market has higher or lower expectations of a company. The image below shows that KSB has a higher P/E than the average (12.6) P/E for companies in the machinery industry.

NSEI:KSB Price Estimation Relative to Market, October 11th 2019

That means that the market expects KSB will outperform other companies in its industry. Shareholders are clearly optimistic, but the future is always uncertain. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.

How Growth Rates Impact P/E Ratios

P/E ratios primarily reflect market expectations around earnings growth rates. Earnings growth means that in the future the 'E' will be higher. That means even if the current P/E is high, it will reduce over time if the share price stays flat. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.

It's great to see that KSB grew EPS by 21% in the last year. And its annual EPS growth rate over 5 years is 5.2%. So one might expect an above average P/E ratio.

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

It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. 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.

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.