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This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We’ll show how you can use Ador Welding Limited’s (NSE:ADORWELD) P/E ratio to inform your assessment of the investment opportunity. Ador Welding has a P/E ratio of 28.39, based on the last twelve months. In other words, at today’s prices, investors are paying ₹28.39 for every ₹1 in prior year profit.
See our latest analysis for Ador Welding
How Do I Calculate A Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Ador Welding:
P/E of 28.39 = ₹384.3 ÷ ₹13.54 (Based on the year to March 2018.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio implies that investors pay a higher price for the earning power of the business. 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.
How Growth Rates Impact P/E Ratios
When earnings fall, the ‘E’ decreases, over time. That means unless the share price falls, the P/E will increase in a few years. A higher P/E should indicate the stock is expensive relative to others — and that may encourage shareholders to sell.
Ador Welding saw earnings per share improve by -3.1% last year. And earnings per share have improved by 10% annually, over the last five years. Unfortunately, earnings per share are down 20% a year, over 3 years.
How Does Ador Welding’s P/E Ratio Compare To Its Peers?
The P/E ratio indicates whether the market has higher or lower expectations of a company. The image below shows that Ador Welding has a higher P/E than the average (19.2) P/E for companies in the machinery industry.
Its relatively high P/E ratio indicates that Ador Welding shareholders think it will perform better than other companies in its industry classification. The market is optimistic about the future, but that doesn’t guarantee future growth. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
Don’t forget that the P/E ratio considers market capitalization. Thus, the metric does not reflect cash or debt held by the company. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
Such spending might be good or bad, overall, but the key point here is that you need to look at debt to understand the P/E ratio in context.