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This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We'll show how you can use Weizmann Limited's (NSE:WEIZMANIND) P/E ratio to inform your assessment of the investment opportunity. Weizmann has a P/E ratio of 8.89, based on the last twelve months. That is equivalent to an earnings yield of about 11%.

See our latest analysis for Weizmann

How Do I Calculate A Price To Earnings Ratio?

The formula for P/E is:

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

Or for Weizmann:

P/E of 8.89 = ₹32.55 ÷ ₹3.66 (Based on the trailing twelve months to March 2019.)

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 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

P/E ratios primarily reflect market expectations around earnings growth rates. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. And in that case, the P/E ratio itself will drop rather quickly. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.

Weizmann's earnings made like a rocket, taking off 106% last year. And earnings per share have improved by 18% annually, over the last three years. So you might say it really deserves to have an above-average P/E ratio.

Does Weizmann 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. We can see in the image below that the average P/E (10.8) for companies in the luxury industry is higher than Weizmann's P/E.

Its relatively low P/E ratio indicates that Weizmann shareholders think it will struggle to do as well as other companies in its industry classification. Since the market seems unimpressed with Weizmann, it's quite possible it could surprise on the upside. You should delve deeper. I like to check if company insiders have been buying or selling.

Remember: P/E Ratios Don't Consider The Balance Sheet

Don't forget that the P/E ratio considers market capitalization. That means it doesn't take debt or cash into account. Theoretically, a business can improve its earnings (and produce a lower P/E in the future) by investing in growth. That means taking on debt (or spending its cash).

Spending on growth might be good or bad a few years later, but the point is that the P/E ratio does not account for the option (or lack thereof).

How Does Weizmann's Debt Impact Its P/E Ratio?

The extra options and safety that comes with Weizmann's ₹5.0m net cash position means that it deserves a higher P/E than it would if it had a lot of net debt.

The Verdict On Weizmann's P/E Ratio

Weizmann's P/E is 8.9 which is below average (15.5) in the IN market. It grew its EPS nicely over the last year, and the healthy balance sheet implies there is more potential for growth. The below average P/E ratio suggests that market participants don't believe the strong growth will continue.

When the market is wrong about a stock, it gives savvy investors an opportunity. As value investor Benjamin Graham famously said, 'In the short run, the market is a voting machine but in the long run, it is a weighing machine.' Although we don't have analyst forecasts, shareholders might want to examine this detailed historical graph of earnings, revenue and cash flow.

Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.