The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We’ll show how you can use Tata Sponge Iron Limited’s (NSE:TATASPONGE) P/E ratio to inform your assessment of the investment opportunity. Tata Sponge Iron has a price to earnings ratio of 8.02, based on the last twelve months. That corresponds to an earnings yield of approximately 12%.
View our latest analysis for Tata Sponge Iron
How Do You Calculate Tata Sponge Iron’s P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Tata Sponge Iron:
P/E of 8.02 = ₹764.15 ÷ ₹95.26 (Based on the trailing twelve months to December 2018.)
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.
How Growth Rates Impact P/E Ratios
Probably the most important factor in determining what P/E a company trades on is the earnings growth. Earnings growth means that in the future the ‘E’ will be higher. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
Notably, Tata Sponge Iron grew EPS by a whopping 27% in the last year. And it has bolstered its earnings per share by 16% per year over the last five years. I’d therefore be a little surprised if its P/E ratio was not relatively high.
How Does Tata Sponge Iron’s P/E Ratio Compare To Its Peers?
The P/E ratio indicates whether the market has higher or lower expectations of a company. We can see in the image below that the average P/E (11.3) for companies in the metals and mining industry is higher than Tata Sponge Iron’s P/E.
Its relatively low P/E ratio indicates that Tata Sponge Iron 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.
Remember: P/E Ratios Don’t Consider The Balance Sheet
It’s important to note that the P/E ratio considers the market capitalization, not the enterprise value. That means it doesn’t take debt or cash into account. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.