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This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). To keep it practical, we’ll show how Orient Bell Limited’s (NSE:ORIENTBELL) P/E ratio could help you assess the value on offer. Orient Bell has a price to earnings ratio of 13.47, based on the last twelve months. That is equivalent to an earnings yield of about 7.4%.
View our latest analysis for Orient Bell
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 Orient Bell:
P/E of 13.47 = ₹164 ÷ ₹12.17 (Based on the year to June 2018.)
Is A High P/E Ratio Good?
A higher P/E ratio means that investors are paying a higher price for each ₹1 of company earnings. 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
Earnings growth rates have a big influence on P/E ratios. That’s because companies that grow earnings per share quickly will rapidly increase the ‘E’ in the equation. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. A lower P/E should indicate the stock is cheap relative to others — and that may attract buyers.
Orient Bell’s earnings per share fell by 52% in the last twelve months. But it has grown its earnings per share by 58% per year over the last five years.
How Does Orient Bell’s P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. The image below shows that Orient Bell has a lower P/E than the average (19.3) P/E for companies in the building industry.
This suggests that market participants think Orient Bell will underperform other companies in its industry. Many investors like to buy stocks when the market is pessimistic about their prospects. 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
The ‘Price’ in P/E reflects the market capitalization of the company. In other words, it does not consider any debt or cash that the company may have on the balance sheet. 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.
How Does Orient Bell’s Debt Impact Its P/E Ratio?
Net debt totals 36% of Orient Bell’s market cap. If you want to compare its P/E ratio to other companies, you should absolutely keep in mind it has significant borrowings.