The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We’ll look at Nelco Limited’s (NSE:NELCO) P/E ratio and reflect on what it tells us about the company’s share price. Nelco has a P/E ratio of 29.2, based on the last twelve months. That means that at current prices, buyers pay ₹29.2 for every ₹1 in trailing yearly profits.

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How Do You Calculate A P/E Ratio?

The formula for P/E is:

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

Or for Nelco:

P/E of 29.2 = ₹272.4 ÷ ₹9.33 (Based on the year to September 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

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. That means even if the current P/E is high, it will reduce over time if the share price stays flat. Then, a lower P/E should attract more buyers, pushing the share price up.

It’s nice to see that Nelco grew EPS by a stonking 149% in the last year. And it has bolstered its earnings per share by 64% per year over the last five years. With that performance, I would expect it to have an above average P/E ratio.

How Does Nelco’s P/E Ratio Compare To Its Peers?

The P/E ratio indicates whether the market has higher or lower expectations of a company. As you can see below, Nelco has a higher P/E than the average company (18) in the communications industry.

That means that the market expects Nelco will outperform other companies in its industry. Shareholders are clearly optimistic, but the future is always uncertain. So investors 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

It’s important to note that the P/E ratio considers the market capitalization, not the enterprise value. 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.