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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 Advanced Enzyme Technologies Limited’s (NSE:ADVENZYMES) P/E ratio to inform your assessment of the investment opportunity. Advanced Enzyme Technologies has a price to earnings ratio of 16.96, based on the last twelve months. That is equivalent to an earnings yield of about 5.9%.

See our latest analysis for Advanced Enzyme Technologies

How Do You Calculate Advanced Enzyme Technologies’s P/E Ratio?

The formula for P/E is:

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

Or for Advanced Enzyme Technologies:

P/E of 16.96 = ₹162.25 ÷ ₹9.57 (Based on the year to September 2018.)

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 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

P/E ratios primarily reflect market expectations around earnings growth rates. When earnings grow, the ‘E’ increases, over time. That means unless the share price increases, the P/E will reduce in a few years. Then, a lower P/E should attract more buyers, pushing the share price up.

Notably, Advanced Enzyme Technologies grew EPS by a whopping 47% in the last year. And earnings per share have improved by 18% annually, over the last five years. So we’d generally expect it to have a relatively high P/E ratio.

How Does Advanced Enzyme Technologies’s P/E Ratio Compare To Its Peers?

The P/E ratio essentially measures market expectations of a company. The image below shows that Advanced Enzyme Technologies has a higher P/E than the average (15.4) P/E for companies in the chemicals industry.

Advanced Enzyme Technologies’s P/E tells us that market participants think the company will perform better than its industry peers, going forward. Clearly the market expects growth, but it isn’t guaranteed. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.

Don’t Forget: The P/E Does Not Account For Debt or Bank Deposits

Don’t forget that the P/E ratio considers market capitalization. Thus, the metric does not reflect cash or debt held by the company. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.

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.

Is Debt Impacting Advanced Enzyme Technologies’s P/E?

The extra options and safety that comes with Advanced Enzyme Technologies’s ₹742m net cash position means that it deserves a higher P/E than it would if it had a lot of net debt.

The Bottom Line On Advanced Enzyme Technologies’s P/E Ratio

Advanced Enzyme Technologies has a P/E of 17. That’s around the same as the average in the IN market, which is 16.1. Considering its recent growth, alongside its lack of debt, it would appear that the market isn’t very excited about the future. Given analysts are expecting further growth, I am a little surprised the P/E ratio is not higher. That may be worth further research.

Investors should be looking to buy stocks that the market is wrong about. 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.’ So this free report on the analyst consensus forecasts could help you make a master move on this stock.

But note: Advanced Enzyme Technologies may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).

To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.