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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 Parag Milk Foods Limited's (NSE:PARAGMILK) P/E ratio could help you assess the value on offer. Parag Milk Foods has a P/E ratio of 11.89, based on the last twelve months. That corresponds to an earnings yield of approximately 8.4%.
See our latest analysis for Parag Milk Foods
How Do I Calculate Parag Milk Foods's Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Parag Milk Foods:
P/E of 11.89 = ₹170 ÷ ₹14.3 (Based on the year to June 2019.)
Is A High Price-to-Earnings 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 isn't necessarily good or bad, but a high P/E implies relatively high expectations of what a company can achieve in the future.
Does Parag Milk Foods Have A Relatively High Or Low P/E For Its Industry?
We can get an indication of market expectations by looking at the P/E ratio. The image below shows that Parag Milk Foods has a lower P/E than the average (14.8) P/E for companies in the food industry.
Parag Milk Foods's P/E tells us that market participants think it will not fare as well as its peers in the same industry. 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.
How Growth Rates Impact P/E Ratios
Generally speaking the rate of earnings growth has a profound impact on a company's P/E multiple. When earnings grow, the 'E' increases, over time. And in that case, the P/E ratio itself will drop rather quickly. And as that P/E ratio drops, the company will look cheap, unless its share price increases.
It's great to see that Parag Milk Foods grew EPS by 14% in the last year. And its annual EPS growth rate over 5 years is 36%. With that performance, you might expect an above average P/E ratio.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. 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.